派克漢尼汾 (PH) 2004 Q2 法說會逐字稿

Good morning. My name is April, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Parker Hannifin second quarter fiscal year 2004 earnings release conference call. 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 then the number one on your telephone keypad. If you would like to withdraw your question press the pound key. I would now like to turn the conference over to Pamela Huggins, Vice President and Treasurer. Ms. Huggins, you may begin your conference.

Thanks, April. Hello, this is Pam Huggins. As April just said, and I would like to welcome you to Parker Hannifin's second quarter fiscal year 2004 earnings release teleconference. Prior to commencing with the actual teleconference I have a couple of comments to make.

First of all, keeping in line with tradition, the slides that we will be using today will reside on Parker's website at phstock.com. Secondly, subsequent to the earnings release and with the commencement of the question-and-answer session, I would ask that you limit your questions please to one at a time. This will provide an opportunity for everyone to participate.

At this time I'll move to the first slide. What you're seeing here is Parker's Disclosure Statement with respect to forward-looking statements. This Disclosure Statement is essential unchanged from the last quarter. However, if you haven't already done so, I ask that you please read it in its entirety. Thank you.

I'll move to today's agenda at this time. I'll be providing for you a summary of the Earnings per Share for the second quarter of fiscal year 2004, along with the Earnings per Share on the year to date basis. I'll then provide an update on Acquisitions and Divestitures for the quarter and the year.

Then an explanation will be provided of the financial results for the second quarter and again on a year to date basis. Segment sales and margins will be covered, followed by a review of the Balance Sheet and the consolidated Statement of Cash Flow. Financial leverage will be addressed, and then I'll conclude with a current update of business conditions within Parker's business segments and the earnings outlook for fiscal year 2004. Subsequent to the outlook, the session will then open to a general question-and-answer session.

The numbers that we will be discussing today are on a GAAP basis with one exception, that exception relates to the sales numbers. The sales numbers have been reconciled from a GAAP basis to that without Acquisitions. Divestitures, if applicable, and currency to allow a valid comparison from period to period. With that, I'll move to the Earnings per Share for the second quarter.

Earnings per Share on a GAAP basis for the second quarter of fiscal year 2004 is $.47 cents. This compares to Earnings per Share for the same period a year ago of $.32 cents, a 47% improvement year over year.

These numbers have been reduced for realignment charges, which amounted to $.02 cents in the second quarter of fiscal year 2004 and $.03 cents for the same period in fiscal year 2003. The fiscal year 2003 second quarter number has also been reduced for $.02 cents that relates to an equity adjustment in connection with a joint venture.

I'll now move to Earnings per Share on a year to date basis. Year to date fiscal year 2004 Earnings per Share on a GAAP basis, again, is $.95 cents. This compares to $.84 cents for the same period a year ago, and equates to a 13% improvement year over year. Again, the numbers I've just quoted to you have been reduced for realignment charges. Realignment charges for fiscal 2004 is $.06 cents year to date, while realignment charges for fiscal year 2003 was $.04 cents.

Again, the fiscal year 2003 Earnings per Share has been reduced by $.02 cents for an equity adjustment related to foreign joint venture.

Moving to Acquisitions and Divestitures, there were no final Acquisitions during the period. However, there is an acquisition pending that was announced on December 8th. That acquisition being Denison International PLC. This business is 180 million dollar Hydraulics Business with a presence in the United States, Europe, and Asia. The advantages to Parker as a result of this acquisition are additional product lines in the Hydraulics Business.

They have profitable performance in Europe, a significant presence in Asia, particularly China, and it will also provide us with some enhanced system capabilities within the Hydraulics Segment.

Moving to the financial numbers at this time, starting with sales for the second quarter: sales for the second quarter fiscal year 2004 were one billion, six hundred and twenty one million, or 6.8% ahead of sales for same period a year ago of one billion, five hundred and seventeen million.

Acquisitions contributed $8.4 million and $6 million to sales for fiscal year 2004 in fiscal year 2003, respectively. Excluding these Acquisition sales, the actual sales increase was 6.7%. Not a big change from the original number.

Foreign currency, mainly the weakening of the Euro, added $79 million to sales for the quarter, and if you exclude the foreign currency effects and the sales from the Acquisitions, the actual sales increase for the quarter was 1.5%. This increase was mainly due to the rebound of the North American segment.

Beginning with the Income Statement for the second quarter, cost of sales for the second quarter decreased from 83% of sales to 82.1%, a 90 Basis Point improvement. This improvement is even better before realignment charges.

The decline in the Cost of Sales and, of course, the increase in the corresponding Gross Margin is the combination of a couple of factors. First of all, the North American rebound in the second quarter, which you'll see later in some of the slides that I'll be covering.

The realization of realignment benefits and then, of course, savings in connection with our strategic procurement and our Lean Programs, what we refer to commonly as our Win Strategy.

SG&A as a percent to sales is consistent from period to period. Before realignment charges, however, it's really down about 10 Basis Points.

Interest Expense, which is a nice story, declined by $2.1 million, or 20 Basis Points, as a percent to sales as a result of lower debt. And you'll see more about this later in the presentation as well.

Interest in Other Income improved 30 Basis Points. This is just a result of less fixed asset write-offs in fiscal year 2004 versus fiscal year 2003, and another nice story is the tax rate decreased from 35.2% down to 31.4% for the second quarter as a result of adjusting our yearly tax rate down to 32%.

Overall, North American - - Net Income for the second quarter increased from 2.5% of sales to 3.4% of sales, solid performance in the second quarter. Sales on a year to date basis of three billion, two hundred and eight million for fiscal year 2004, there at 3.4% of the same period a year ago. Sales a year ago were three billion, one hundred million.

Acquisitions contributed $13.4 million and $10.6 million to sales for fiscal year 2004 and 2003 respectively. Again, excluding these sales the increase in sales year over year was 3.3%.

F X again, mainly the strength of the Euro contributed $136 million to sales, so if you exclude the currency effects and the sales from the acquisition, sales actually declined 1.1%. This decline is mainly due to North America, which was down 6.9% in the first quarter.

Moving to the Income Statement, on a year to date basis, again, we had a Cost of Sales decrease. Cost of Sales decreased from 82.5% in fiscal year 2003 down to 82%. Again, this improvement is even better before realignment costs.

Also affecting this number is what Parker calls PIM. You've heard us talk about this in the past, but the increased pension, insurance, and medical cost. A second item affecting these numbers, not readily apparent, is the Aerospace Margins. I'll talk more about that once I get to the Aerospace Segment.

SG&A is up slightly on a year to date basis, mainly due to pension and higher expenses in connection with Parker's incentive programs. Interest Expense is consistent from year to year. Little lower as a percent, about 10 Basis Points.

As a result of lower debt, the effect of which you'll see in the second quarter.

The tax rate, again, as I had mentioned earlier, has been lowered to 32% for the year. Last year at this time it was slightly above 34%.

Overall Net Income increased from 3.2% to 3.5% of sales.

At this time I'll move to the segment data for you. Starting off with sales of $703 million for the second quarter. 5% above sales for fiscal year 2003, same period, of $670 million. Acquisitions did contribute $5.3 million to sales for the quarter, and if you exclude the acquisition sales, sales were really up 4.2%.

Currency, while minor, did have an effect on sales in the amounts of $4.7 million, and again, excluding the currency effects and the sales from the acquisition, sales were up 3.5%. On a year to date basis, sales of one billion, three hundred and eighty eight million were down 0.7% with acquisition and the currency effects there.

If you exclude the benefits the sales were actually down almost 2%, 1.9% on a year to date basis. Margins for the second quarter improved from 4.1% a year ago to 7.5%. That's a 340 Basis Point improvement representing 83% improvement period over period.

Margins on a year to date basis improved from 5.6% last year to 7.2% this year. While not as good as the second quarter, it represents 160 Basis Point improvement.

The magnitude of this improvement, obviously is more than the rebound in volume in North America. Contributing factors, again, were Procurement, Savings, and Lean, as a result of realignment and process improvement.

Moving to Industrial Rest of World, sales of $442 million for the second quarter are 18.1% higher than sales of $374 million for the same period a year ago.

Acquisitions contributed $3.1 million to sales, for the quarter, so excluding these sales, sales only increased 17.3%. However, the currency effects are much more of a factor in this particular sector and added $60.7 million to the sales figure, excluding the currency effect and the sales from the acquisitions, sales only increased 1%.

On a year to date basis, sales of $864 million compared to sales of $740 million for fiscal year 2003 representing almost a 17% improvement. Again, acquisitions played a part and contributed $3.6 million to sales, excluding that sales on a year to date basis were up 16.3%, slightly below the 16.8%.

Again, currency on a year to date basis, material factor for this segment contributed $105 million, and if you exclude that, with the sales from acquisitions, sales were up 2.1% on a year to date basis.

Moving to the Operating Margins for this segment, Operating Margins for Rest of World for the second quarter compared to the same quarter a year ago improved from 6% to 6.7%, 70 Basis Point improvement. Margins on a year to date basis improved from 6.6% last year to 7.1%, 50 Basis Point improvement.

Moving to Aerospace at this time, sales in the second quarter of $272 million are 1.3% less than sales of $275 million for the same period a year ago.

Excluding -- here we didn't have an acquisition, we add Divestiture in fiscal year 2003, so excluding the Divestiture sales from second quarter of 2003 of $6 million, sales actually increased by 0.9%.

Currency effects, again, while minor in this particular segment, contributed $1.8 million to sales, and excluding the F X impact and the Divestiture sales, sales were relatively flat for the quarter at 0.3%.

On a year to date basis, sales of $539 million were 2.5% less of sales of $553 million for the same period a year ago. Breaking out sales from the subsequent disposition sales were down slightly by 60 Basis Points.

Again, while currency was minor on a year to date basis did it add $3.3 million to sales and excluding this in the sales on the subsequent divestiture sales were actually down 1.2%.

Going to -- moving to Margins at this time, the largest impact was on the Margins. Margins for the second quarter, compared to the same quarter a year ago ,went from 15.5% down to 11.3%. That's a 420 Basis Point decrease. On a year to date basis, Margins went from 15.4% down to 12%.

This decline was anticipated as a result of 9/11, SARS, and the Iraq War, obviously it resulted in a shift of business mix for Parker. This wasn't unanticipated, it very much was. We had basically said that in the Aerospace Segments that margins would steadily decline throughout fiscal year 2003, bottoming out in the fourth quarter. While margins aren't where we would like them to be, double-digit margins are pretty good.

Moving to Climate and Industrial Controls, this is the segment that we broke out separately this year. Sales for the second quarter came in at $145 million. This is pretty flat with sales of $144 million for the same period a year ago.

Again, acquisition -- well, acquisitions in this particular segment had no effect whatsoever. There weren't any acquisitions that contributed to sales during this period. However, currency contributed $3.9 million to sales. Again, due to the strengthen of the Euro. Without the impact of this sales, or the currency effect, sales actually declined 2.5%. On a year to date base, sales of $301 million for 2004, they were below sales of the prior year by 2.7%.

Currency, again, contributed $6.6 million to sales, and excluding this, sales were actually down 4.9%.

In spite of decreased sales, however, Operating Margins increased from 6.9% from the second quarter last year to 7.2% this year, and on a year to date basis, Margins increased 120 Basis Points from 8.1% to 9.3%. So there's really good performance in this segment.

Moving to the last and final segment, which is Other, which is a small player for us, sales of $60 million for the second quarter increased 11.4% over sales of $54 million for the same quarter a year ago. Acquisitions again, there weren't any acquisitions in this segment that contributed to sales. Currency does have an impact on this segment, however, contributing close to $8 million to sales and excluding this to $8 million, sales were actually down 3%. On a year to date basis, sales of $116 million were 11.7% ahead of the same period a year ago, fairly consistent with the second quarter.

Currency contributed $13.6 million to sales, and if you excluded this, sales actually declined 1.3%. Margins improved from 4.7% to 7% to the second quarter, and from 6% to 8.5% on a year to date basis. This is a 68% improvement over -- for the second quarter. Again, very solid performance in the segment.

Moving to the Balance Sheet, starting off with cash, well, I'd like to actually talk about cash later in connection with debt. So at this time I'll move to Accounts Receivable. Account Receivable increased by $27.5 million. However, DSO decreased by two days.

Inventories are down $58.8 million from a year ago, and this represents an 8-day decrease in Cost of Goods Sold in inventory.

Property, plant, and equipment is down $42 million, this is a result of the reduced Capital Expenditures. Capital Expenditures on a year to date basis is 2.1% of sales, substantially down from our historical levels. The goodwill increase of $60 million is mainly currency related.

Other Assets increased about $99 million, mainly due to the booking of the minimum funded pension liability in June, just a -- we made a discretionary contribution to our pension plan that approximated 110 to $120 million, also contributing to the number.

Going to the liability side of the Balance Sheet, if you combine notes payable and long-term debt here, debt decreased by $343 million, and you'll see later, looking at, it's actually down over about $400 million year to year, or on a year to date basis.

In addition, to reducing the debt year over year in this amount, there's over $130 million of cash on the Balance Sheet.

Parker's debt position is very good, and again I'll cover this more in more detail later, but, you know, just to re-emphasize, our debt is substantially down, close to $400 million. We have over $130 million dollars in cash on the Balance Sheet so we feel we're in a real good liquid position moving forward.

The changes in the deferred taxes, if you combine the Asset and Liability accounts, they're basically the result of, again, the minimum pension liability that we booked in June.

Shareholders equity increased by $33 million, much less than earnings for the period. However, again, this is due to the other comprehensive loss in connection with booking the minimum pension liability. If you recall, we took about a $297 million dollar hit to Shareholders' Equity as a result of that pension adjustment.

Moving to the statement of Cash Flows, we're very proud of our Cash Flows for the six months ended December 31st, '03. We add record Cash Flow year in fiscal year 2002 and we feel that we're off to a very good start in fiscal year 2004. Cash Flow from Operations is $378 million versus $261 million a year ago.

As a percentage of sales, Cash Flow from operations is 11.8% versus 8.4% for the same period a year ago.

Depreciation and Amortization, you can see it's much higher than the Capital Expenditures for the period. Capital Expenditures, again, running at 2.1% of sales, well below our historical average. The working capital contribution is healthy and very positive.

Also, as you can see, in addition to -- as I mentioned before, the $130 million that we have on our Balance Sheet in Cash, debt has come down by $409 million as shown on this Statement of Cash Flow. So not only did we -- do we not have any commercial paper outstanding, we have healthy cash reserves and we've been able to reduce our debt by over $400 million.

Looking at our financial leverage, debt to equity is 27.2%. The lowest it's been since fiscal year 1999. It's down from 35.6% at the end of fiscal year 2003. This is a gross number. However, if you looked at it net of cash, the debt to total equity would be around 24%. This is well below our goal of 34 to 37%.

If you pro forma the Denison Acquisition, the net debt -- or the gross debt to equity percentage would remain fairly consistent with what you're seeing right now here at the 27.2%. Feel that it would be much lower than 30%.

If you took into account the currency impact on the debt, too, the debt to total equity percentage would be even lower.

At this time, I'll move in to the Parker's order rates and what we're seeing in business segments. In North America, we've had five months of either flat or increased orders. We haven't seen consistently positive results like this since March of '02. Of course, you remember, going back, to March of '02, after seeing positive orders like that, it wasn't sustainable. It didn't stay there. Those numbers, however, were often very easy comparisons, as well. We're still cautious, more optimistic than we have been in a long time.

We're seeing strength, a lot of strength in the construction market. Strength in Heavy-Duty trucks, strength in the Semicon market.

The Mobile market is particularly strong in North America, not so strong in Europe. Rest of World, we've had four months of consistent positive numbers in Rest of World. Rest of World, however, tends to be a little more choppy for us.

As you can see on the graph, Europe is the cause of that choppiness for the most part, Asia Pacific and Latin America, they remain consistently strong.

Aerospace orders, just to remind you, are on a rolling 12-month basis to avoid the unevenness or the choppiness that comes with that business segment. We've had nine months of positive numbers, but this is really the result of easy comparisons in this particular group.

As I said, going back, Margins continue to decline in fiscal year 2003 as we anticipated, with a bottoming effect in the fourth quarter. We really don't see a come-back in this segment until fiscal year 2005.

Climate and Industrial Control, they had very strong orders in November. However, they took -- they declined in December. Again, orders in this particular segment are somewhat choppy. It's heavily reliant on the Automotive market, however, which is somewhat down for them at this particular point in time.

Moving to our outlook for fiscal year 2004, starting with sales growth, the way that this outlook is presented, it's presenting sales growth for fiscal year 2004 versus fiscal year 2003. In North America we're expecting 1 to 4% increase year over year, and Industrial Rest of World, 13 to 16%. Aerospace, will be down in the range of 2 to 5%. The same for Climate and Industrial Controls, 2 to 5%, and we see the sales increase for Other in the range of 4 to 7%.

The outlook for Operating Income, again, this is -- it should be recognized that this is the change versus fiscal year 2003. Industrial North America, our forecast is 37 to 47%. Industrial Rest of World, 35 to 45%. Aerospace will be down 15 to 25%. Climate and Industrial Controls zero to 10% increase, and other at 65 to 75% increase.

Moving to below Operating Margins, Corporate Administration is expected to be up in the range of 15 to 20%. Interest Expense, plus or minus 5%. Other Expense and Income Statements, fiscal year 2003, and as we mentioned earlier, our tax rate will drop to 32%. So, after that, I think we are ready to move to the open Q and A session.

Thank you. At this time I would like to remind everyone in order to ask a question, please press star then the number 1 on your telephone keypad. We ask that you limit your questions to one and one follow-up. We'll pause for just a moment to compile the Q and A roster. Your first question comes from Gary McManus of J.P. Morgan.

Hi, Gary.

Good morning, Pam. In your Outlook Statement, you have -- I mean, I'm comparing what you're saying today versus what you said in the previous conference call. You have North American Industrial Sales down a bit -- down more than what you thought before, you now say it's up 1 to 4, you said previously 2 to 5, but you have profits now up significantly more, now up 37 to 47%, versus you previously said 20 to 30. So can you go through why you made those changes?

Okay. On North America, we said 2 to 5%? Yeah, I think that, as you can see in the second quarter, the rebound in North America was pretty good. First quarter was down substantially. It was over 6%.

Second quarter, we really saw, you know, a rebound in that particular segment. When we do our numbers, and we're, you know, looking at our forecast, we try to take all these segments together, you know, to come up with this, and we obviously look at where we are in terms of Sales year to date, okay, and if you look at where we are in terms of Sales on the year to date basis, North America is down.

And we try to determine, you know, what would we have to do for the first -- or for the second half relative to the first half in developing our numbers, and I think once you work through the numbers, you'll see that in the second half, there's really a healthy increase that's baked into that forecast. So I think once you sit down and work through the numbers you'll see that even, you know, in spite of the fact that on a year to date basis North America is down, there's a fairly healthy increase. So the one - - that I wouldn't be mislead by the to 1 to 4%. There's a nice increase baked into that forecast.

And go through why you raised the profit assumption so much in North American Industrial. It was 20 to 30, now you say 37 to 47.

Gary, quite frankly it's the strength that we're seeing in our orders. Like I said, we have five months of consistently good orders. It's the strength that we're seeing in the Construction Equipment Market, Construction Equipment is really good. It's also the benefits that we're seeing as a result of the realignment. That has taken place in the last two years, and it's the result of the Procurement and the Lean Savings that are coming through.

Okay. Thanks.

Your next question comes from David Raso of Smith Barney.

Good morning.

Hi, David.

Trying to think through the mix here, maybe describe the Operating Income Increase. Looking at the sales numbers, as you implied, you basically had first-half actual North American growth of negative 0.6%. Your guidance range implies the second half growth should be about 2.6 to.5.

One thing I want to ask before we go on the mix, is the orders, the orders have been running now double-digit for two months in a row in North America, before that 8%. The sales top line of 2.5, roughly, to 8.5 growth in the second half, what is the disconnect between the order growth rate to have a sales guidance that's below your order rate? Again, the guidance range is 2.5 to 8.5 for second half North America but your order is already running above that.

Well, if you recall, when we did our initial - -- when we prepared our initial forecast going forward, we had a fairly healthy back-end-loaded plan.

I'm just trying to get a feel between the relationship between the order rate and the revenue growth rate.

The other thing, David, we don't want to get out ahead of ourselves on that. We - -- we're seeing improved orders, but we don't want to get out - - feel we've increased our forecast, we're happy with that, like I said, back in March of '02 we had four months of order increases. That wasn't sustainable.

I know the conditions are somewhat different this point in time versus before. And we did have already baked in our original forecast, like I say, the back half was high for us. So, you know, we just don't want to get out ahead of ours. We're going to tell you -- as we get the orders we're going to tell what you we see but we think that the 8.5% that you referenced --.

At the high end.

Yeah, in spite of orders being down on a year to date basis -- -.

No, no, I'm sorry, I didn't say that. What I said was your recent order rate in North American Industrial has been running low double- digit, and really even high teens even.

Right.

Now, that said, that's, generally speaking, your momentum going into your fiscal second half. Your guidance range for the full year implies second-half growth in North America of only 2.5 to 8.5%.

So that -- what I was fishing for, is there something about maybe the orders are coming in that are longer lead time orders? I don't see the significant growth in your Receivables suggesting that. So that's why I was just trying to figure out why your order growth rate, shouldn't it be more representative of where your Sales guidance is.

You're right, some of those orders are very long lead time. Some of the things that you see in, i.e., Aerospace, some of the markets are long lead time. Not in North America as much. Typically we have a six-week backlog.

But no change in the backlog when it comes to extended orders, you know, longer lead times than normal, so it doesn't help explain it, but we can talk off line about that.

Well, David, I think that the recovery that you're seeing, though, is OE driven in many respects.

Okay. And then on the OE side, the increase in your OE growth rate from your previous guidance, but again the sales growth a little less than before, the mix, when I hear Semiconductor -- I mean, clearly Semiconductor, Telecom, Instrumentation, and particularly in Seals, the [inaudible] Group have great margins.

Construction, I don't necessarily think of that necessarily as higher Margin, per se. Is there something going on in the mix, and is it particularly Semiconductor, or something I'm not seeing that the mix improved from the last quarter's guidance to give you confidence to raise your OI even more than, you know, a change to sales?

It's just pretty much what we're seeing as a result of, like I said, the Procurement savings, the Lean savings as a result of the process changes.

Okay. Thank you very much.

And the realignment, David.

I appreciate it. Thank you, Pam.

Thank you.

Your next question comes from Ann [Duiginan] of Bear Stearns.

H, Pam, this is Ann [Deigman.]

Hi, Ann.

Could you give us some color on Aerospace and why you expect the Margins to be consistently lower going forward? I know that you had to renegotiate your insurance contract. Is that part of it, and should we think of the Margins going forward then as being permanently lower than we saw previously, or is it simply just military mix?

Right. Well, you know, when you look at the Aerospace Business, I know that lots of people, the RPM's are up, but, you know, actually what's happening -- what is really happening for Parker in that business is obviously the change in the business mix. The Commercial Aftermarket Business is the business that is really off for us, that is our highest Margin business.

So even though RPMs are up and would you think that the aftermarket would be up, quite frankly, what's happening are the number of flights are down. More people are in seats, not necessarily, you know, more flights. The wear and tear on the planes is up, planes, most of the airlines aren't showing a profitable -- they're not expecting any type of profitability until 2006, so as a result of that, they're really not buying.

I mean, they're really not buying. You look, planes in the desert had gone up every month. There was a small reduction recently. But the number of planes that Boeing, for instance, is projecting for 2004 isn't much different from to '03, and the same with this Airbus.

So what's really caused our Margins to decline is the change in the mix of the business, the Commercial Aftermarket, obviously, being the most profitable for us, that has gone down, and Military has remained relatively stable, but again, you know, there are Margin differences between the Commercial and the Military, and the MRO happens to be our highest Margin business, which is down.

So obviously, we've had increased insurance cost in the Aviation Business as a result of the 9/11, and there's also pension and medical expenses that are hitting that segment. So it will be down in fiscal year 2004. We're thinking that things should come around to 2005.

The other thing that's happening in that business that are going to help Margins going forward are obviously, the Regional Jet Business. As you know we've had some good wins on that Regional Jet Business, and we think those are absolutely the programs to be on, and that going forward that will make a difference for us.

Just as a follow-up, the new insurance contract that you had to sign, is that a two-year contract or one-year contract?

One-year.

Okay, so you'll to have renegotiate that again next year?

Correct.

Is there any significant engineering investments going on right now for the Regional and Military programs that should decline as those programs go into production?

No, I mean, there's ongoing type of engineering charges that, you know, are always ongoing, the Joint Strike Fighter. There's some program expenses related to that. But there's nothing that's going to be out of line.

I mean, we've always had those development expenses and those development expenses are always way ahead, so we're always working on those. No, I don't think so there's anything unusual that's really going to make a difference in what you see on the bottom line.

Okay, thanks.

Thank you.

Your next question comes from Andy Casey of Prudential Equity Group.

Good morning.

Hi, Andy.

Just, I guess, on the cost side of the equation again, kind of following up on Gary and David's question, but a different line, on the Corporate Admin, your outlook went from 5 to 10% versus last year, up to 15 to 20. Could you give a little color as to why the change there?

Yeah. We've had -- it's basically the result of the incentive plans. We've had increased Accruals for our Incentive Plans which is, you know, a good thing for us actually.

It's a bad thing in terms of expenses but it means that, in fact, we're doing better than we thought that we would be doing at this particular time. So we did have to increase the Accruals for expenses in connection with Incentive Plans. We also, there are some legal fees in there in connection with some of the things that are going on presently that are adding to that number, Andy.

Okay. Thanks a lot, Pam.

Your next question comes from Mark Koznarek of Midwest Research.

Hi, Mark.

Hi, Pam. Good morning. I have a question about the outlook with regard to the Margin improvement, you know, the Income growth. As I look at how we've performed in the first half, for both the North American Industrial and Rest of World, according to my calculations we are showing incremental Margins of around low 20s for the North American side of the business and actually only teens in International, and to get to your Income growth targets, it assumes a major pickup in both of those in the second half.

And I'm wondering if you can talk in terms of what has really happened here to move the needle that much in the second half. Is it big improvement in your Win Strategy initiatives? For instance, was there a major price increase January 1? Or, you know, some very notable event? Can you -- can we explore that a little bit?

Right. Well, I guess, you know, to start off, I'm a little bit surprised, I guess, to -- that you think there's such a notable increase. I think, you know, I mean, we have an increase baked in there, but I don't think it's that notable.

Once you work with the numbers, I think you're going to see that, yeah, we have an increase in there. Industrial North America year to date is 7.2%, and if you look at our forecast, I don't think it's substantially much higher than that. Now, Rest of World - --.

Maybe we can talk off line, because your midpoint of North America is, you know, 42% growth, right, for Income, and that implies the second half earnings are going to be, you know, somewhere in the $65 million a quarter, and last year they were $40 million a quarter in the second half.

That's a big pickup. So, you know, that's what I want to explore. Is there some major event that has occurred like a significant price increase, or some, you know, very notable reduction in your, you know, raw materials or other procurement costs or other notable change?

Mark, it all goes back to what, you know, we've been talking about. We've been talking for a long time about the Win Strategy. In fact, to the point where I think people are tired of hearing us talk about it.

I've had people say to me, if I have to hear about that Win Strategy one more time, but, up, it's a program that we have been working on for a long time now. And all the legwork up-front to get those contracts in place, you know, I mean, we're starting to see the benefits of those now.

And when I look at it in general, I mean, yeah, North America has had to rebound. I think when we went into this year we said that Europe, we really didn't feel that we were going to see a big come-back in Europe, and it so happened that Europe, I think, did perform better in the first quarter. Second quarter, falling off a little bit, Asia Pacific and Latin America remain strong.

So, you know, when you look at, I mean, Industrial North America on a year to date basis they were at 7.2%, our forecast isn't much higher than that.

Industrial Rest of World on a year to date basis is 7.1%, and again,, you know, our forecast isn't much higher than that. So, you know, we're really running at the same run rate as our first half.

If you look at last year, the first quarter was extremely strong. And then we had a big drop-off in the second quarter, and then the third and fourth quarter were fairly consistent.

This year, we had a good first quarter, and the difference being we had a really good second quarter. And I think the conditions are a little bit different as well in the marketplace today going into the second half than it was a year ago, plus we're seeing the benefits of all the legwork that we've been doing in connection with Procurement Savings and leaning out our processes.

Okay. Let me just ask one further clarification, which would be in the change in your outlook from where you were in October versus right here for North America, for example, would the change in Income expectation be more this Win Strategy improvement, or is it mix, product mix and end-market related improvements?

I think it's a combination of obviously -- you know, we always do better in the second half versus first half.

If you look at historically, we've always been around the 47, 53. So, obviously, that's baked into there. We expect to do better in the second half than the first half, and also when you look at our order rates, the realignment benefits that we're getting and the savings from the Win Strategy. I think pretty much explains it, Mark.

All right, Pam. Thanks very much.

Thank you.

Your next question comes from Barry Bannister of Legg Mason.

Hi, Barry.

Hi, Pam, how are you?

Good.

Of the $5.8 million in crease in Corporate and Administrative Expense, could you delineate with a little more clarity what was the incentive portion and perhaps what was the PIM?

I didn't hear the last. What was the incentive portion and what was the - -?

PIM.

Oh, okay. PIM. You know, I really don't have those numbers before me. I really don't have the breakdown on that. There was legal in there as well.

You mentioned that.

Yeah.

We'll follow up with that off line because I am curious about it. It's become an issue with machinery companies in the last couple of quarters.

Okay. That's fair.

The other question related to that in terms of Margins, is you're spending at a 2.2% rate of Capex to sales, and yet your six-year average is 4.4.

Right.

Are you permanently less Capital intensive, and to what degree could we expect that to ramp up in the next few years?

Right. Yeah, definitely if you look historically our Capex has been -- hasn't been as high as 5%, so it is really low. I don't think that being at this point is really sustainable. I think for this fiscal year, you know, we're looking at 3 to 3.5%.

It's definitely going to be on the low end of the 3%, 3 to 3.5%. Maybe even coming in at just a touch less. But I don't see us being able to stay at the level that we're at right now. But I don't think that we'll ever go back to the range of 5% that you've seen historically.

As a result of the Lean process that we're going through and that most manufacturing companies are going through, you know, you don't have the big heavy machinery that you've had in the past. You're making customer orders on adjusted time basis with much smaller equipment. In a cellular set up, and you just don't require that type of Capital Expenditures. So I don't see it going back historically to the levels that it's been. I think 3%, around, somewhere around 3%, is probably a good sustainable level.

In the next four quarters.

Yeah, I think for fiscal year 2004, you know, we might even fall just a touch shy of that 3%.

Okay. Thanks.

Your next question comes from Joanna Shatney of Goldman Sachs.

Hi, Joanna.

Hi. Can you guys just give us some detail about what you're seeing in January? Is there any acceleration from what we saw in the last couple of months? Look like a lot of the order improvement, although it's still pretty solid year over year, it's not really sequentially improving.

Secondly, if you can talk about why your sales in North America were up only 5% versus the order book being up more much than that in the quarter?

To address your second quarter first, again, I think, yeah, North American orders are substantially, but - --.

Is it shipping days?

What happens, Joanna, is when those orders come in, okay, they don't really ship immediately, and what happens is, is in December we had a fairly good shipping month, but those items didn't go out the door. I mean, they really didn't. They came in, and they're in backlog. They haven't gone out the door yet.

Are we seeing strong orders continuing in January and any acceleration?

You know, January is continuing along at a good pace. That's probably all I'd like to say about that. But it's continuing along at a fairly good pace. North America seems to be doing, you know, as I said before, North America seems to be doing fairly well. Rest of World, you know, it's a little - -- or Europe's a little soft for us.

Okay. Thanks.

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

Good morning, Pam.

Hello.

Hi. Just first to make sure, clarification. None of these revised forecasts include the effect of Denison, right?

Correct.

Okay. Pam, according to my calculations it looks like the -- I mean, with very little change in the Sales forecast, the Operating Income forecast has gone up by, round numbers, $.25 cents a share. Just to cement the point, if I understand correctly, the primary driver of the higher income forecast is a more favorable outlook for Win Program contribution in fiscal '04. Is that correct?

Well, I think there's more than that. Yes, there's Procurement savings, there's the Lean savings that we're seeing. The volume will be higher in the second half versus the first half.

But that doesn't affect your full-year forecast.

Right.

Right? In fact, it doesn't look like your second-half forecast for volume has changed very much. That's why it sounds to me like Win Program, Procurement, Lean, the things you've been talking about, explain the vast majority of the improved forecast.

Yeah, if you're comparing just first half to second half, you're exactly right. I mean, it's basically a result of this benefits from realignment, and the Procurement savings as well as Lean. But, you know, our run rate for the second half is fairly similar to the first half.

You're talking about in terms of Operating Margin, right?

Right.

Right. Okay. And to follow up on a question that's been asked about Aerospace, you know, in the last couple of years you all have talked positively about being able to sustain Operating Margins in that segment in a 12 to 13% range. The press release suggests that the 11 plus that we saw in the second quarter is a better estimate for a sustainable rate in the second half. Am I reading that correctly?

I think when we've been talking about the 12%, that's fairly -- fairly consistent. I mean, that's what we think we'll see for the year.

Okay, very good. Thank you, Pam.

Your next question comes from Jeffrey Hammond of McDonald Investments.

Hi, Jeff.

Good morning. I guess tin terms of the Acquisition pipeline, you talked about still being below that target with the Denison Acquisition. Can you talk about appetite and what you're seeing in terms of valuation and pipeline?

Right. That's a good question. Right now, I mean, obviously we're focused on the Dennison Acquisition, and, you know, there's, quite frankly, there's a lot in the pipeline. There's a lot out there right now.

I think with the downturn and with the rebound somewhat, there are a lot of people who are, you know, making themselves available. We continue to look at it. Obviously, with our cash and where we're at in terms of our debt capacity, we're going to continue to look at it.

We obviously have the rating agencies to consider in connection with that, and so, you know, we want to maintain our rating, so we always make sure that we're keeping them apprised of what we're doing and making sure that we can maintain those.

There are some ways of doing some things that will help us in the acquisition process, you know, without hurting our ratings, so we're obviously looking at that on an ongoing basis.

There are a lot of people who want to sell because they're realizing that, hey, if you want to compete today you have to be global, and they just can't get themselves to that point, and Parker can help them do that.

There are other situations where people are reaching retirement age and they really don't have anybody to take over the business, and, you know, Parker can help them with that.

We stay close to all of the potential acquisition candidates that we see out there, and, you know, you never know when you're going to get the call, you never know when the train's going to come by, but we continue to look at them, and, like I say, we also do it in view of maintaining our ratings.

Now, as the demand environment has improved, have you seen these targets kind of raise their valuation expectations or take a linear approach in terms of demand?

No, I don't think so. You know, the people who want a lot for their business want a lot for their business regardless, it seems. That's kind of the way I've seen it. The ones who are really unreasonable out there, they continue to be unreasonable regardless, so, no, I don't think we really are seeing that. I think people are being fairly consistent with their expectations.

Okay. Thank you.

Your next question comes from John McGinty of CSFB.

Hi, John.

Good morning, Pam. Just to start with a clarification, the forecast -- and if you said this, I apologize -- the Industrial Rest of the World sales growth at 13 to 16% versus the previous 5 to 8, what currency is embedded in that? In other words, what's the growth ex-currency in the 13 to 16? In other words, is it really any different than the 5 to 8 you had previously?

John, I'm not sure - - are you talking about Rest of World here?

Industrial Rest of World sales growth, 13 to 16%.

That number is calculated just based on what it actually was for the period. Okay?

No, no, I'm sorry, I'm looking at your forecast.

Yeah, the forecast, it's looking at that time actual number.

But what I'm saying is, what are you embedding in that for the full year '04?

The same as what you're seeing.

For the first half?

Yes.

Okay, the same as the first half.

Yes.

In the orders that you have seen, everyone's been talking about how strong the orders are and you haven't responded. I mean, sales have not responded quickly. Is there a higher portion of OE business than normal? You always talk about broadly at 50/50.

Are we seeing a much higher portion of OE business in these orders than the traditional mix if we ship to the 60, 70% OE instead of 50/50?

I think you've hit it. John, I think what's happening is distribution has tend to lag here. I think, you know, with the rebound, distribution has absolutely tended to lag, and I think we are seeing that the uptick is driven on the OEM side.

Okay. Which actually means not that there won't be a higher increase in orders, I mean, I'm sorry, in your shipments, it just means somewhat later on.

Right. Like one of the things that happened is I noticed some people raised their estimates in December, based on orders, and I was a little bit, you know, I don't want to say disturbed, but thinking those orders weren't going to go out.

But, Pam, you just raised your full-year estimate something like $.20 cents.

I know, I know. But, John, you know, I just want to caution you, I don't think -- I think that when you work through the numbers and see where we're at for our forecast, yeah, we have raised it, but I don't want to get out in front, either.

But if I can come back and - --.

I don't think we can get ahead of ourselves here.

Let me ask Rob McCarthy's question one other way. Let's forget about first half/second half. Let's just look at all of '04 versus all of '03. Okay?

Okay.

You have not raised your volume forecast for '04 in a meaningful way. Arguably you may have -- I don't know, I haven't worked out the net net.

If we take the currency up I think you've probably lowered it marginally, but let's call it the same, 'cause who can sweat a percentage - -.

On the other hand you substantially raised the profit forecast for the year based on the success to date of anything you -- - whatever you want to call it, the Wins, Lean, Procurement, the restructuring, all of those other things.

But if I look at this, you are not -- -I mean, just looking at your numbers, your second-half Margins are not -- or your full-year Margins, there's not a heck of a lot of increase in the Margins in the second half versus where you were the first half.

Mathematically on the midpoint. The question is - - here's my question. If there is a volume increase, and you're saying there isn't going to be one, but if there's a substantial volume increase at some point in the second half, do we not have the same leverage on the up side than we have traditionally -- should traditionally have coming out of the bottom?

Yeah, I mean, you know, the number that we always talk about is 30%, and, you know, that may be a little higher when you're first coming out, and then it may be a little lower as you move out of the recession.

But - - .

Somewhere averaging that. So, you know, I wouldn't say that it would be any different than what we've always said. You know, I mean, yes, the orders are up, but you have to look at the really low base.

I understand that, Pam, but you've raised -- you've beaten every quarter, you've finally raised your expectation, you've stayed conservative throughout, I understand what you're saying, but the point is, you are raising your full year guidance without really doing much to the top line at all.

Right.

Thanks very much.

Yep.

At this time I would like to remind everyone, in order to ask a question, please press star then the number 1 on your telephone keypad. Your next question comes from Alex Blanton of Ingalls and Snyder.

Hi, Pam.

Hi Alex.

Just one more try at this to make sure we've really understand it. If we look at October and November orders, forget December, the average increase there was 9.5%, and that does not include acquisitions and does not include currency, correct?

Correct.

So that we have to compare that - - this is North America - -with the 3.5% sales gain in the quarter before currency and acquisitions. So there's six percentage points difference there. October, November orders versus the actual sales increases for the quarter. Can that all be explained by a shift, as John said, to OE versus distribution?

I think you can attribute some of that, some of that, because, I mean, if you recall, when we were talking about the order increase, I think, you know, it was OE focused in many respects.

Well - - .

Distribution, while picking up, I think lagged that.

Well, you said - -.

I think that's some of it.

Some of it. What's the rest? Wouldn't it be a good idea for you to look at that and say, why are our orders and our sales not corresponding to one another better here?

We do look at that, Alex. I mean, we do look at that. In fact, we do that analysis every time before I come in here to talk to you.

Well, I mean, we're all asking for your conclusion here, and you've been very reluctant to tell us.

Well, we just don't want to get ahead of ours, we really don't.

Well - - .

You know, we're basing -- if you look at the second half run rate to the first half, I think you'll see some consistency there. In terms of the sales, we're really not -- we're not seeing any.

It's really not a question of that. The analysts are seeing these orders rates, and they're trying to build models based on sales increases, which hopefully correlate with increases in orders. And there doesn't seem to be the correlation that we would look for here, and we're trying to figure out why, because if you want the analysts to be conservative in their numbers, you can't at the same time give them these order rates which exceed the sales gains and not explain why.

Because analysts are likely to look at the order rate and see, gee, based on this, we're going to have a really strong second half top line, stronger than the company is forecasting. But if you were to explain and say, well, there's a reason why these order rates are not corresponding with the sales, then the analysts wouldn't do that. That's what we're all struggling with here.

Okay. Alex, let's you and I talk about this later today. We can continue this conversation

Okay, one more thing.

I think we've talked around it, talking about the OEM orders, but let's you and I, you know, let's talk about this.

Okay. One more thing. You said Aerospace Margins would bottom in the fourth quarter. Can you give us an idea where?

Yeah, and I think we have. We said that they would probably be in 11 to 13% range, hopefully centering around 12, 12.5.

In the further quarter.

Yeah.

Okay, thank you.

Your next question comes from Karen [Ugelheart] of [GIC.]

It's been answered, thanks.

Hi Karen.

Hi.

Ladies and gentlemen, we have reached our allotted time for questions and answers. Ms. Huggins, could you have any closing remarks?

No, I don't. Thank you everyone, and I will be around today to take any calls that anyone may have, so I'll look forward to that, and have a great day.

Thank you for participating in today's Parker Hannifin conference call. This call will be available for replay beginning today at 1:15 Eastern Time through tomorrow, January 21st, 2004, at 11:59 p.m. Eastern Standard Time. The conference ID number for the replay is 4681972. Again, the conference ID number for the replay is 4681972. The number to dial for the replay is 1-800-642-1687, or 706-645-9291. Thank you.