派克漢尼汾 (PH) 2004 Q4 法說會逐字稿

Good morning. My name is Tina, and I will be your conference facilitator today. At this time I would like to welcome everyone to Parker Hannifin Corporation's fourth quarter fiscal year 2004 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's 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 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

Ms. Huggins, you may begin your conference.

Thanks, Tina. I would like to welcome everyone to Parker Hannifin's earnings release this quarter as well. Before starting I would like to just address some administrative matters. First of all, the slides that we'll be using today in connection with the presentation, they'll remain on Parker's website. You can access those slides through phstock.com. Those slides will remain there until the next earnings release. As customary, we'll have our Q&A session at the end of the earnings release, and once again I would ask that you please limit your questions to one at a time in order to give everyone a chance to participate. I'm also pleased to announce today that at the Q&A session I'll have joining me Don Washkewicz, our President and CEO; and Tim Pistell, our Vice-President of Finance and Administration and CFO.

I called attention to our safe harbor statements, again, if you haven't read those statements, I encourage you to do so. The statement is essentially unchanged from previous earnings releases. Again, the numbers that we'll be using today in the presentation are on a GAAP basis. We've made one acception and in order that you can make a valid comparison from period to period on sales, we've adjusted sales from a GAAP basis to that without acquisitions in foreign currency. Just a few minutes on the agenda for today. While the slides have a lot of information on them for you, I won't be covering them in detail. I'm going to try to just provide a summary of the quarter for you, and the year as well, hopeful that I'm just focusing on the highlights. The areas that I'll highlight include earnings per share and sales growth. I will make just a few comments on the influences on sales and earnings and of course I'll talk about order trends. At the end, I'll conclude with a brief overview on the balance sheet and our cash flow position. And then of course I'll close with the guidance and the outlook for fiscal year 2005.

So to commence with the earnings per share for the fourth quarter and year-to-date, as you know well in line with the press release what you've seen already this morning, earnings per share came in at $1.05. However, I want to call your attention that the $1.05 includes 5 cents from the gain on the sale of a business unit and 2 cents in realignment charges. After adjusting for the gain and the realignment charges, the earnings per share on an adjusted basis is $1.02. This $1.02 is above the mid-point of the previous guidance of 85 to 95 cents and above consensus. If you look at the same quarter a year ago, earnings per share was 42 cents, again there was a gain on the sale of a business unit included in that 42 cents, and there was 6 cents in realignment. Adjusting for those 2 items, the adjusted earnings per share is 44 cents. So fourth quarter of fiscal year '04 versus fourth quarter of fiscal year '03 results in 132% improvement.

Moving to the full year earnings per share came in at $2.91, again, the $2.91 includes 5 cents from the gain on a sale of a business unit and 9 cents for realignment. So the adjusted earnings per share is $2.95. This compares to GAAP earnings per share of $1.68 a year ago. And again, a gain on the sale of a business unit was included for 4 cents, and there was 16 cents in realignment costs, of which 2 cents represented an equity adjustment. So adjusting for those items, the adjusted earnings per share is $1.80. So on a full year basis, $2.95 compared to a year ago of $1.80 is a 64% increase.

Moving to income from operations, for the quarter, versus a year ago, it includes -- it improved 510 points going from 7% to 12.1%. And on a year-to-date basis income from operations improved 240 basis points from 7.5% to 9.9%.

Now, I'll just talk a little bit about sales for the quarter, and on a year-to-date basis sales were up in the fourth quarter 20%. Once you exclude 3 points for acquisitions and 2 points for currency, the organic growth was 15%. On a year-to-date basis, sales were up 11%, and again, adjusting for acquisitions and currency, sales were up 6% for the year. Just to take you back a little bit in time, as you recall after the first 6 months of the year, we were actually in a negative position of 1%. We had about 9% growth in the third quarter which was our first quarter of real growth for the fiscal year. So with the third quarter and the fourth quarter, the growth that we're seeing has really put us in a solid positive position for the year. The positive sales growth that you're seeing really was experienced across all segments of Parker's business. The increase the result of end market strength in almost all of our major markets. We've seen significant activity in heavy-duty truck and in the mobile market, basically anything that has wheels has been very strong for us. Semi conductor and oil and gas has also been strong, however, those markets as I mentioned before, aren't quite as large as the first 2 markets that I mentioned. However, the increases in those markets have been a lot stronger than the other 2.

Aerospace sales were up 11% in the quarter; however this equates to 2.8% in the year. The commercial market is emerging and the aftermarket is showing signs of recovery. On the defense side, you know that in fiscal year '04 with the drop in the commercial market, defense has been our real support and has held us up in fiscal year 2004 continues to be strong. China, when you look at a globalization trends, China is our strongest in terms of growth. In fact, Asia Pacific as a whole is very strong for Parker right now, and Latin America remains strong as well.

Going to order rates which is an indicator of future revenues we've had 11 months of consecutive order increases on a year-over-year basis. For the quarter, orders were up 26% and of course just as a reminder this excludes acquisitions and currency. However, I want to remind you that starting in the fall, we will be up against some fairly tough comparisons in North America. Moving to the rest of the world order rates, we've had 10 months of consecutive increases in order rates. And again for the quarter, orders we up 20%. This order growth is being driven by all regions in the rest of the world; Latin America and Asia Pacific as I mentioned are strong. But even when you look at Europe right now, all the major countries that Parker participates in are also doing well. Climate and Industrial Controls, while orders have improved in the last quarter, this segment tends to be pretty lumpy for us. I should note though, however, here that the segment did hold up through the recession and as you'll see later, this segment is projected to be flat going into fiscal year 2005. Moving to Aerospace order rates, they're up 14% for the quarter and against tough comparisons. You know, we're a long way from our peak levels in aerospace, as I mentioned earlier defense has held up subsequent to the 9/11, defense has been the real support system here. But there are a lot of encouraging signs within this segment. The RPMs are up, the number of planes coming out of the desert, there's continued strength in defense, and the regionals provide a real opportunity for Parker.

At this time I'll move to earnings -- address earnings. Segment operating income for the quarter was up 109% versus the same quarter a year ago. Again, this was lead by North America with a 230% increase, while international was up 138%. While Aerospace and Climate and Industrial Controls didn't see these types of increases, the margins in those 2 segments are very strong. Aerospace at 13% for the quarter and Climate Industrial Controls at 11.8%. The higher margins that we're seeing are obviously due to volume. We're running more production through less facilities. Also due to our restructuring efforts, we've closed approximately 100 facilities in the last 3 years at a cost of $100 million. We've made movements to low-cost countries and most importantly our win strategy. The results can be seen on the gross marin line pushing up over 200 basis points. For the quarter alone the improvement was 460 basis points. It should be noted that rest of world margins came in at 9.9% for the quarter. This is the highest margin that we've seen in rest of world since March of 2001. I want to remind you that we did close the Dennison [ph] acquisition in the last quarter. It has contributed to the bottom line and has been accretive. On a year-over-year basis, operating margins are up in every segment this quarter. The same -- that is true of last quarter as well, other than aerospace. This is clearly the result of the Win Strategy.

I just want to take a minute to discuss the Win Strategy again as I did last conference call. The Win Strategy is Parker's initiative with respect to network procurement, lien, and strategic pricing. We've done very well on our procurement program, it can be seen in the margins. We measure our progress on lien through inventory reduction, productivity improvements and reductions in capital expenditures. We had said before that we were going to give you 6% to the bottom line as to this program: 2% in procurement, 2% in lien, and 2% in strategic pricing. We also said that that would come in the form of 1% in fiscal year '03, 2% in fiscal year '04, 2% in fiscal year '05, and 1% in fiscal year '06. We feel that we're on track and are meeting those goals. Inventory has been reduced by 51 million without Dennison in the current year. DSI has declined 8 days, and that includes Dennison. Capital expenditures have been reduced from 2.5% to 2%, and P P & E in line with that reduction in capital expenditures has decreased by 113 million. Of course, this excludes Dennison, and our gross margins they've increased to 19.2% from 17.2% a year ago.

Now, I'll just move into the individual segments, not spending a lot of time on those segments, trying to point out the highlights. Going to Industrial North America. You can see that after you exclude acquisitions and currencies, we had growth of 19%. More importantly, we had an 840 basis point improvement in the margins in the fourth quarter going from 5% up to 13%. A lot of good progress in this particular segment, and Industrial Rest of World, effecting this segment more so than any other segment is obviously the currency which is the result of the strengthening of the Euro, showing a sales increase of 32%, however if you back out acquisitions, which basically accounted for 10 points, and currency, which was 7 points, you really see 15% growth in this segment. Again, though, really good progress on the margins the fourth quarter, again, emphasizing the 9.9% that I talked about earlier. 440 basis point improvement for the quarter. But even on a full year basis, margins went up 200 basis points. In the Aerospace segment, this is a segment that we've been saying all along that the margin would go down in this segment. We said, we had been projecting about 12%. We actually did a little bit better than that. We came in for the full year at 12.4% helped by the fourth quarter which was at 13%. Obviously this segment is hit very heavily by the PIM, what we call PIM, which is pension, insurance, and medical, and obviously it's hit due to the business mix subsequent to 9/11.

Moving to the segment on Climate and Industrial Controls. This is the only segment that we have that on a full year basis is basically flat in terms of sales. However I want to emphasize here that this segment they did extremely well as a result of -- in their margin area as a result of the movement to low cost countries and of course the Win Strategy. You can see that they've increased their margins from 9.5% to up to 10.7%. Good improvement in that segment. On the Other segment, while this segment is as material as the previous ones, this team has done a remarkable job. They've been able to improve their cost structure. This is just another example where the Win initiatives have really paid off for us.

Moving to the end here starting to zero in the close, covering the balance sheet. We obviously have a strong position. Our balance sheet is very strong at this time with 183 million in cash. We don't have any CP outstanding. We've had working capital improvement, as I mentioned we reduced inventory by 51 million and our DSI is down 8 days. That's equivalent to about 13.9% of sales, 2% improvement throughout the year. PP&E, down 113 million excluding Dennison, obviously our depreciation has exceeded our capital expenditures. And in shareholderers' equity, we're almost at the 3 billion mark increasing by 462 million. Our debt to total cap ratios, very good. We did retire some large maturing debentures this year to you tune of about 375 million, total debt was reduced by 415 million. So we've been able to reduce our debt to total cap from 36% down to 25%. But if you look at that on a net basis it's 21.3%. So we're in a good leverage position, cash flow is extremely strong. We came in at 662 million for fiscal year '04, but I just want to point out something here. That in fiscal year '03 we made voluntarily contributions to our retirement and benefit plans in the amount of $108 million. This year we continued on that pace, even increased it and made contributions of $146 million. Had we not made the voluntarily contributions to the retirement and benefit plans this year we would have exceeded 800 million in cash flow.

We have one adjustment that we need to you make going forward prior to getting into the fiscal year 2005 outlook. We have reclassified one of our business units from Industrial to Aerospace. And the fiscal year 2005 guidance is based on numbers after making this adjustment. So it's important that you do make this adjustment, so we would like for to you reclassify 76 million from Industrial to Aerospace and adjustment that you'll need to make on the operating income margin side is to decrease Industrial North America from 9.9% to 9.6%. And then we would like to you increase Aerospace from 12.4% to 13%. And that's on a total year basis, and that adjustment will need to be made prior to calculating the fiscal year 2005 guidance which is what I'll get into now.

We've changed the guidance just a little bit. When I get the margins we've gone back to basis points. So first I'll start with the sales, the change fiscal year 2005 versus 2004 I'm giving you the percentage increase in sales by segment. Starting with North America, sales we're projecting are going to be up 6 to 8%. Industrial Rest of World 8 to 10%. Aerospace, the guidance is 3 to 5%. And then Climate and Industrial Controls and the Other segment, the sales expectation is between a negative and positive of 1%. Going to the operating margin percentages, North American Industrial we're expecting the margins to increase by 120 to 220 basis points, Industrial Rest of World 70 to 160 basis points, Aerospace 30 to 120 basis points, and Climate and Industrial Controls as I'd mentioned earlier, projected to be relatively flat on the low side, down 40 basis points and on the upside 50 basis points. And Other, again, on the low side it will be flat and on the high side up 100 basis points.

Moving to the items that fall below the operating margin, corporate admin, we're projecting that it will be down 1 to 3%. Interest expense obviously due to the lower debt down 8 to 10%. And then other expense in income an increase of 75 to 100% which that is really -- that's a large percentage increase basically due to the sale of a business unit in fiscal year 2004 that won't be repeated. Plus some additional pension expenses. The tax rate, we came in at 30% for fiscal year 2004. The normalized rate, however, is 32.5%. We're expecting the tax rate to be about 31% next year. Just to remind you in the third quarter of this year, we did have a 10 cent earning per share gain from discrete tax item that benefited and obviously allowed us to come in at 30% for the year. Full year guidance fiscal year 2005 is expected to be $3.30 versus $3.70, and for the first quarter we're projecting 70 to 80 cents.

At this time this concludes my prepared remarks. And I would like to open up the session to Q&A. I won't be going over the forecast risk. You can read those for yourself. So at this time I think we'll open it up to Q&A. And as I mentioned before, I have Don Washkewicz, our CEO; and Tim Pistell, our CFO who have just joined me.

[Caller Instructions]. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Gary McManus with JP Morgan.

Good morning, Pam and everyone else.

Good morning, Gary.

You know on June 14th you gave fourth quarter guidance of 85 to 95; you came in at 1.05. Can you talk about the reconciliation between those 2 numbers? Was it because of you know did you not assume that gain was going to be in the fourth quarter, did the second half of June end up being a lot stronger than you thought? Just kind of give me a sense on those 2 numbers.

I think you're pretty much right on. At that time we weren't sure. You know, we can't anticipate when these things are going to happen, when you're working on something like that. You know, you have -- it's very volatile especially when you get down to the end. And you're just not quite sure. So, yeah, we didn't really -- we couldn't bake that in, so to speak, at that particular time. And obviously June did come in strong. June was a strong quarter for us.

Okay. And second maybe and Don or Tim could chime in on this. Is you know you show your debt to cap target -- your current debt to cap is well below your targeted range. You're generating a lot of cash. What are we going to do with all the cash? You know you did 200 million of acquisitions in fiscal '04 could we see the pace increase substantially? Can you do a billion dollars? What's the likelihood of a share buyback -- meaningful share buyback being announced any time soon.

Well, maybe I could just comment -- make a few comments on that, Gary. Couple things, first of all, as far as how we're going to use the cash is to continue paying dividends, of course we have a 48-year record there is of increasing dividends. The second area is really to support some new market and product opportunities that we have internally and we're wrapping up investing in these areas. And those would be such as in the life science area, we've started a new business unit there, we've started a new business unit in a fuel cell area. So we're going to be putting more and more investment in those key target and market and product areas. As far as the acquisitions, we are actively looking at a number of them. We certainly weren't going to get very active on acquisitions in the middle of the recession. Of course we didn't want to lose our debt ratings. And we were able to maintain those debt ratings throughout the recession. So we were very cautious I guess throughout that period. But of course, we have the leverage down now and we have the ability to pick up the pace a bit. And we are in the process of talking to a number of different candidates so -- or opportunities, I should say. The key there is that we don't want to get on any tangents. It really has to fit on our platform. It has to bring either new technology or expand our existing technology or market presence. And we're not looking at high risk opportunities either. So and then, Tim, do you have comment?

The only thing I'd add, Gary, to your question on share repurchase -- this is Tim. As you know, we do have an authorization that's open and we have made a commitment that we would repurchase enough to offset any creep from benefit plans, et cetera, and we are doing that. In fact, you can notice that the share accounts actually were down slightly in the fourth quarter from the third quarter. So but that is just enough to offset creep. It's not a huge program, and we would you know we would right now be focused more on growth opportunities than to announce a huge share repurchase program.

Okay. Thank you very much.

Your next question comes from the line of Andrew Casey with Prudential Equity.

Good morning.

Good morning.

I have a question on the guidance. If looks like the mid-point revenue growth is somewhere around 6% and then the EBIT margin growth expectation is somewhere around 200 basis points or a little bit more than that. If I gave you 100 basis points on Win Strategy, that kind of gives me about 100 basis points of improvement in the base business. Can you kind of walk through what the expense items would be, you know, in terms of pension and all that? And then why if I'm correct is it only 100 basis points? Thanks.

Andy, this is Tim. Let me just start discretely with the pension issue. We know that the -- we are -- because of the -- the way the accounting works on the pensions, we know we're going to have an increase on the pension expense, just because of the amortization of that. And so we will be picking up -- I think it's in the neighborhood of 30 million more. So of additional expense that we have to -- built into the plan. But let me -- the way we -- the way we run the businesses and the way we look at it, it's not exactly the way you have stated there. Basically we're looking for all of our business units to deliver a 30% marginal return on sales, okay. So you are dealt the cards you're dealt with. Those are the ones you have to play with. But at the end of the day, if we're seeing incremental revenue we want to see you drop 30% to the operating margin line. And that's how we hold people accountable despite all the other vagaries that can occur. So I can't -- you know, slice it or dice it differently than that. That's just our expectation.

Okay. Thank you.

Right.

Your next question comes from the line of David Raso with Smith Barney.

Good morning. Tim, to your train of thought. The mid point guidance is 6 2 on the top line and a 34% incremental margin, pre corporate expense. This past year you put up 5 6 of sales with an incremental of 31.

Correct.

The guidance when you talk about the risk, you talk about the cost side. But the guidance seems like there's more confidence in the margin than the top line. Can you elaborate on that? Are you seeing something on the top line besides, of course, your back half of your fiscal year your comps get harder. Where's the confidence in the margins and where's the maybe not quite the confidence in the top line?

I think we have a lot of confidence, both in the top line and in the margins, David. I think -- clearly as you know that an industrially, we sit here today with 6, 8 weeks of backlog, that's all we have booked. Aerospace we got a little more. We got about a year's worth. By industrially that's all we have. So it's, you know, we have confidence in what's going on and on both the top line and the bottom line, but we are as I say it is a little harder after you get out past 12/31 to understand really where the markets are going to be. So. as I say, I think there's confidence in both. Don, do you have something?

Just a couple of comments, David, on that as well. I think the other thing to keep in mind is that the acquisition that's we've made, okay, we've gone through a lot of integration there and those are starting to come back, and that gives us confidence certainly as from a margin standpoint there. The restructuring, of course when we did restructuring, we said that we'd try to get that paid back with in the 12, 18-month period that time frame now has passed, and we expect to see these kind of improvements in the margins as a result of the restructuring efforts that took place. And then lastly we've been talking about the Win Strategy and the 3 initiatives that we've rolled out and those are now embedded in our organization and they are producing very, very positive results. And we're not done. This is an ongoing effort, so we expect continual improvement in margins from that standpoint as well, so really -- I'd really highlight those 3 areas that give us you know continued confidence that these margins are going to continue to improve. Our goal is 15% operating margin. We've been saying that now for 3 years. We're marching down the path to get there and it's really these things that are taking us down that path.

The reason I ask the question, it would be very impressive to get those kind of margins with a top line growth that's not much stronger than last year. Because usually the incrementals begin to wane a little bit the further the maturity is of the recovery. But you're not putting up too strong an aerospace guidance. I can't really say it's mixed. There must be some strong pricing there. Is there pricing built in beyond the material cost more than 100, 200 basis.

No, not really. There's nothing significant in the way of pricing other than to recoup our material costs. Like I said, I think if you don't watch what we're doing on the Win initiatives, you won't pick up what's really happening here. I think you've got to really watch those very closely.

Right. Thank you.

Your next question comes from the line of Ann Duignan of Bear Stearns.

Hi, good morning, everybody.

Good morning, Ann.

Hi.

Just a quick clarification on your corporate admin expenses on the quarter. They were up significantly above guidance. Was that variable compensation or something like that?

Ann, this is Tim. You're very observant picking that up. Yes, they were up. They were at 1.7% of sales in the quarter. Interestingly, a year ago they were at 1.1% of sales. Two very different environments. Last year, no one was getting any incentive pay and we were reversing all of that. This year of course with the strength of the third and the fourth quarter we did have to beef up the accruals on incentive pay, that's number one. Number two, there were some legal accruals that's we had to provide for and so we took that into in the fourth quarter, so it was not just incentive pay there were some legal accruals we put aside. Really more importantly is looking on the year-to-date basis, because what we try to do is keep our corporate G & A at 1.5% of sales or less. And -- and we really try to drive it down below that 1.5 % of sales sales, and frankly, we were at 1.3 the year before we got up to 1.5 again this year. Again, it's mostly those incentives and those legal accruals. But we are going want to -- you know we are going to plan on working hard to get those down. I mean, what we think ultimately would be great is 1.0% of sales. And I think -- we spend a lot of time looking at this corporate G & A number because we pride ourselves in having at 1.5% or less. I think it's one of the lower numbers in our group and we work it very hard.

Okay. And just a follow-up then, thanks for the explanation. Follow-up number one. The legal accruals are those on the aerospace side for the lawsuit or is there something else?

Yeah. Unfortunately we did with the adverse decision that the first level in California on the Silk Air situation, which you know -- just I mean it was -- astounded us all. But basically if the jury is not given all the facts, they're not going to come to a good conclusion. So we're clearly gearing up the money, because we absolutely are going to appeal that decision, we're filing the motions in the courts and we will -- we will take it to appeal. We will see this thing through to the end. Because it is such an incredulous outcome at this stage.

It does appear that way. And then talking about the aerospace the outlook seems a little conservative particularly given that you'll start shipping Embrey Air [ph] products in this fiscal year. Can you give us some color on that?

Ann, I just came back from Farmbro and I would say that -- first of all, I think the aerospace is projected up here to what, 4 to 5? -- 3 to 5%. So there's a positive improvement there. I think the commercial OE side is going to take a little bit longer. I don't think we're going to see much of that in '06; however at the show it was very upbeat from the standpoint of new airplane orders and so forth. Now, I think that again we're probably a year off on the commercial OE side. Planes are coming out of the desert. We've heard that. It's over 100, I guess now to have come out of the desert just in recent weeks. That's good. When we get these planes flying they need our parts. So I think that's positive. I think on that aftermarket side we certainly hope that continues and that would be a very big plus for us, and there's no indication now that it would not. I think Embrey Air now has shipped about 23 170s, we're all over that plane. The new 170 that was just certified. They shipped 23, I believe, in the last 6 months and that number is going to increase a little bit. I think they're targeting about 30 for the next 6 months. Somewhere in that range. So about 60 on -- an annual basis of about 60. We have about a half million dollars on each one of those. So you can see the difference between 23 and 30, that'd be about 7 times a half a million. That would be a little bit of a plus there from Embrey Air. But again we're at the early stages of that, too. The defense side, I think when we talk about defense and military I think our outlook would indicate that that's going to continue pretty much at the levels we're seeing right now, which is at a very nice level. We don't anticipate them going up a lot from here but maintaining at this level would be very good for us. So that would be a little color on the aerospace side.

What I'm hearing from you, Don, it seems to me there may be more upside potential upside risks, rather than downside risks tot he range of 3 to 5%?

I think you're absolutely right. If I were if I were a betting man I would bet that based on what I've seen and what I'm hearing that if anything, we would see more upside than downside from here. And again, we'll have more opportunity to update at every three-month period here as this becomes clear going forward. I think this is our best look right now and certainly that can change. And I think like you said, I think the change would be on the upside.

Okay. Thank you very much.

Your next question comes from the line of Joanna Shatney with Goldman.

Good morning.

Good morning, Joanna.

If we take the high end of your margin guidance for the industrial rest of world business we're still not breaking the double digit levels. Can you give us an update on where we are with the restructuring? How much of -- maybe those realignment costs, and I'm not sure why we're not getting into the 10% yet, and I know Jack's been doing a lot on getting Europe up to speed, but I thought Dennison would help us get there a little faster.

I think in the quarter, Joanna, I think we had 9.9. So we're a tenth away, so we're getting close. A lot of the activity in Europe is coming together very nicely. The sales forces have been integrated. A lot of the warehousing has been integrated now. A lot of the restructuring has been, you know, pretty much behind us. And we're starting to see some of the benefits of that and that's really what's driving the margins. I think in the fourth quarter last year at about 5.5% on the international side, we're up to 9.9. So it shows that we're almost twice the margin. And again there's more, we think, to come, and as we move forward there's still more activity going on there. And again keep in mind also that really the tail wind was really lagging in Europe compared to the rest of the world. You know, Asia has been strong. Latin America has been very strong. The U.S. came back and Europe was still in the doldrums. Europe has just recently now started to come back. So we see they're -- as you get a little tail wind in Europe that's another positive going forward for us going down the path here. So we think that those margins are going to continue to improve over time. And we will get that up above 10. Like I said we're with in a stone's throw here of 10 right now.

So the structural changes are finished so we should just think about this as being a volume issue, and when volumes get back to healthier levels, we will get there, right?

I don't think I would say they're finished. They're never finished. We're still working a number of initiatives over there. Plus we're also working all the Win initiatives there. It's not totally finished. A lot of the heavily lifting is done because we had a lot of restructuring as far as plant closures. There's still a few in process. We're always looking at that and we'll continue to look at that. So I wouldn't count that out 100%. The heavily lifting done; there's still more to come. Again tail wind is going to help us from a volume standpoint, but we we expect to get more from these initiative as well.

Okay.

Joanna, this is Tim. I had one other thing to add. I think at the beginning this of the year we said that we thought this fiscal year '04 that we just completed that we thought our realignment activities and so forth we would be down in a 9 or 10 cent, range, okay. We also said that we felt that there really wasn't anything extraordinary about that. If you're running a business of our size and complexity -- I mean we should be doing probably 9 or 10 cents of realignment every year as just part of the running of the business, and low and behold when we got all done, it did come in at about 9 cents. The reason I say this is that next year we'll do more -- as Don said. Things aren't completely done, and you can't record some of these expense until you do them. We will incur another -- I don't know 8, 12 cents worth of realignment restructuring. But we're really not planning on breaking that out. We don't -- you know, we're down now to what we think are really things that's necessary to run your business, so the guidance we gave you, of course, doesn't -- I mean it's all in there. We've taken that out of there and we're just going to incur it, and hopefully get away from reporting these few pennies ever quarter.

Thank you.

Thank you, Joanna.

Your next question comes from the line of David Bleustein with UBS.

Good morning, everybody.

Good morning.

Just a couple clean ups. What discount rate have you built into your pension fund for fiscal 2005?

The we're using a 6.25% discount rate, David. And the long-term rate of return assumption is 8 1/4. And we have -- we verified that those are very solid, you know maybe towards the conservative end, but very solid assumptions.

Pam, we model quarterly so could I trouble you to send out the restated figures for the reclassified businesses by quarter, and then my final question is, can you walk through what's happening with your purchase raw materials in terms of availability and whether or not your -- lead times from you to your customers have changed materially over the last 6 to 8 weeks?

Sure.

Yeah. As far as the availability has been fine. As you know, we had an issue around the turn of the new year where a lot of these raw materials there was a lot of pressure in the market and a lot of demand, of course. Ramp up in demand and of course, the pricing pressure came with that. As you know and as you can see in our results we didn't absorb that. We told you we weren't going to absorb that and we didn't. We passed those on. That's the situation now. It's pretty much subsided we don't see any major changes on the near term. We've heard people talking about you know raw materials being a major issue. We don't see that as the case. We have entered into long-term agreements with some of our suppliers, this is was ongoing throughout this recessionary period and I think that put us in a little better position maybe vis-a-vis some of the other companies from the standpoint of supply. So we haven't really been curtailed to any great extent on supply. We're able to get the materials. The pricing has subsided a little bit. It hasn't come down a lot but it hasn't gone up much more either. So we feel pretty confident that there aren't going to be any issues there. As far as the customers are concerned, the customers have gone from a push back situation, which was maybe at the turn of the new year to a situation where they're more interested in getting material now because they see their own orders ramping up and they aren't worried about as few cents far as material costs, so we see the whole move is a whole lot different, because they want material. They're not as concerned, of course they're always concerned about the cost but they're not as concerned. If they can't get material they can't run their lines. So that's kind the way we see it right now.

Okay, terrific. Thank you.

Thank you.

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

Good morning, Mark.

Hi, how are you? Question here on Wins, the Win Strategy. Because the leverage that you've seen so far in North America and also international, even though there we're starting from a small base, of course. But if you exclude the increase in the pension expense this year, the leverage has really been phenomenal. There's a couple quarters scattered where it's been nearly 100%. So what I'm driving at -- I'm wondering if Wins is actually ahead of schedule. And you mentioned you've got -- you're expecting the contribution of you know 1% to margin last year, then 2% this year, 2% in '05, and 1 in '06. It is actually more front-ended loaded then that? Have you had more success such that the rollout is more like 1, 3, 1 and 1 or something like that? You know, are you father along in Wins than you've indicated so far?

No I think we're pretty much on target. I mean there's different initiatives when we talk about the Win initiatives, there's several different ones, and each one is in a little different phase. But I think when you aggregate the three, we're pretty close to what we had to you originally. I think the thing to keep in mind, Mark, when you're looking at some of the margins, though, also is the impact of the acquisitions and the fact that we brought on acquisitions and went through a lot of restructuring. These acquisitions did not bring with them margins that were commensurate with the rest of our margins so we had work to do, and we pretty much told you that. We bought these acquisitions at the peak. Our timing wasn't the best, but nevertheless they were -- it was the right thing to do, and so the impact of the restructuring on the acquisitions and integration of the acquisitions have made a major impact certainly on the turn around, as well as the general restructuring throughout the right of the Company, just right sizing the Company for the level of activity that we had. I think you've got to keep those two things in mind as well. Those are very significant. These are big acquisitions that we took on. Bigger acquisitions than we ever took on than the history of the Company, and they took a little bit more work and a little bit more time, but we're happy that now we're where we are. And frankly, I'm glad we did do this in the recession because we had more time to work on them in the recession than we would have had right now. But Win going forward, I think what we see is very positive forecast for Win. We think we're right on target as far as what we told you early on. Frankly, a little surprised that we want had to change that outlook. We told you 1, 2, 2 and 1 over the four-year period and that's pretty much the way we're seeing it roll out.

So we should really expect Win then to be a neutral contribution to incrementals because it added 200 in '04 and another 200 in '05 so you're not getting an acceleration, it's going sort of steady --

That's right, Mark.

-- [overlapping speakers] that's the right way to think about it. Okay. Then one other final margin detail. You indicated that semiconductor as been extremely strong in terms of percentage growth. And I recall back when we had North America Industrial peak margins of nearly 15% back in 2000, that was part of the story then as well. Has that been a material contribution to mix in recent quarters? And if the semi cycle slows down, should we be thinking about weaker mix in '05?

Mark, this is Pam Huggins speaking again. As far as the semiconductor goes, you know it's a smaller market for us. It doesn't have the same ramifications as some of the other markets, but, yes, the margins are very high in that business. And, yeah. I mean if semiconductor is off entirely. But there's something that we've done with respect to area that's going to help us going forward. We had a very high fixed cost base within the semiconductor business, and we've taken steps to reduce that cost base. So, yeah, if semiconductor is off it's going to be off for Parker, but have you to remember it's not one of the biggest markets and secondly we had reduced or fixed asset cost base within that particular business, and so you're not going to see the same downturns that's you've seen in the past.

Great, Pam. Thank you.

Thank you.

Our next question comes from the line of Ned Armstrong with FBR.

Good morning, everybody.

Good morning, Ned.

With regard to the Dennison acquisition which you mentioned had been accretive thus far, can you talk a little bit about where you're most pleased with the performance and where you're a little bit less pleased and how you might get that second part up to expectations?

Well actually, this is Don here. We've been extremely pleased with the acquisition. First of all, the company wasn't broke to begin with. The company was doing extremely well, they had a very, very good market position in the products that they offered in these high capacity pumps as well as the van pump product line. They had a tremendous market position in Europe. And from a margin standpoint, they were doing very well. So the integration of that unit really had more to do with integrating the sales companies into our sales companies for instance and there's still a little bit of that going on out there, because you don't want to have a sales office across the street from another one. So you're going through that integration and so forth. But there was no major like shutdown -- major facility type integration that needed to be done, because they were doing so well and they were structured very well and a very well run company. So I would says there's be been absolutely no downside that I can think of at all. It's been all positive that I can -- I'm just trying to think back in my own mind. I haven't heard anything negative on that acquisition so whatever.

So it's fair to say you're pleased both from the perspective of your markets and revenues, as well as the ability to fold in the operations within the Parker structure.

Absolutely.

Okay. Thank you.

Your next question from the line of Oizan Moreno with Jefferies.

It's Yvonne Varano, thanks. You had talked about the growth that we've seen in China, Asia Pacific and Latin America. Is it possible to tie any percentage numbers to that so we know how strong stong has been?

Yvonne, this is Tim. Say it again. In the three areas of --?

China, latin America and Asia Pacific.

Well, the Latin America, start with that. And this is just remarkable throughout this recession. They basically were growing at double digits, low double digit right through this recession. Okay. Again on the lower end but growth in double digit. In terms of Asia we've been doing you know 2 or 3 times better than that. But you know we don't really break it down necessarily by the countries. We have -- I mean, again, you'll have some months where you'll really have some huge spikes and then it will be less than that, but again, very, very healthy grow rates.

Okay.

We kind of look at China, for instance, just looking at one, our target there is to grow at a multiple of their GDP growth and that's kind of what we're tracking.

Okay.

We're not just tracking with GDP we're tracking a multiple of GDP.

And then we talked about the new business initiative and how much of your CapEx is expected to go into those in '05.

In the new business initiatives?

Yes.

The -- well, you know, when the acquisition is brought in, as part of their presentation on that acquisition is what the capital requirements might be. We don't really find that -- very little do we find them deviating from our what norms are. So generally we would -- they'd probably come in saying that they would need 2.5, 3% CapEx. And we would build that actually into the valuation model. It would all get built in.

Okay. But you started some new business units?

Oh, on the new business units? I'm sorry like the life science and the fuel cell?

Yes.

Oh, I'm sorry. I'm miss understood.

That's okay.

Well, we have those built in as well and sometimes of course those CapEx to sales can exceed 100% at the beginning, clearly, as they're getting tooled up to land the new business. The but they aren't huge investments in either case. They're all within our 3.5% of sales for the year.

Okay. And then have you factored in anything on your sales line for these businesses in '05?

Have we put -- are there sales in the forecast?

Yes.

Yes. But there again they're in start-up mode. They're very small. They're not huge. You know, if we go out 2 or 3 years they become pretty darn big so we're excited to see that happen.

Okay. Thank you.

Your next question comes from the line of Jeff Hammond with Keybanc Capital.

Good morning, everyone.

Hi, Jeff.

Good morning, Jeff.

I guess I want to understand the what you're assuming for mix in your margin guidance for aerospace. Maybe run through you know the rationale there.

The -- well, I think we've touched on it. We're expecting -- okay. Before the downturn in aerospace, okay, back in 2000, if you will when everything was humming along, as you know our mix was about 60% commercial and about 40% defense, and based on the commercial having collapsed and the defense having picked up, today we sit here with about 50/50 between commercial and defense. Okay. In both cases they run around 55% OE and 45% aftermarket. Now, what we're saying in the plan '05 is that the really no change on the military defense. We think that that's been a fairly constant -- it upticked a little bit after the 9/11 and the new -- the Bush Administration you know spending. It upticked it a little bit and it's held itself very steady since then. Now what we're looking at right now and in aerospace on the commercial side which is now the other half. We're looking for a recovery, first of all, in the OE side. In fact, we're seeing some of that now, as I think we've touched upon. We're getting orders from the regional jet people that we weren't getting before, okay? So for like the Embrey Air 170/190 program we're seeing some of that, and of course, we're hearing out of Boeing and Airbus that, Hey, they're going to increase their build schedules and we'll start getting the orders for that. And let's say that's half of the half. Then the aftermarket will come later. You know, that's a function of how many people are flying out there and I think they're beginning to do that. But that's going to take a little while longer. So you know as I say, what you have a a static situation on military defense, that's half, you've got a little bit of improvement on the 1/4, let's call it the commercial OE, and we're still kind of waiting for the commercial aftermarket to really kick in.

Okay. Great. I just wanted to make sure I understand the commentary on semiconductor truck. Those have been very strong. Your guidance assumes little bit more tempered growth. But if that continues its then it's potential upside to the guidance?

Well, let me just mention -- this is Don. Semiconductor the one -- one of the issues there you probably read the papers like we have. We see orders through the end of the calendar year and then we don't see anything beyond that. So we've almost have to look at this as a quarter-by-quarter business because of the way the orders are coming in here and the visibility we have going out beyond, for instance in our case beyond the next 6 months. So we've got visibility for 6 months, and we frankly, we don't have any visibility beyond that. So we're kind of with the blinders on. And this market, as you know, has been a little bit fickle with pretty wild swings, so we're a little bit cautious there.

On heavy duty truck if you look at the last peak in heavy duty truck as far as retails sales of class 7 and class 8s, it occurred in about March of 2000 I believe it was if I got that date right. That was about 35,000 units that's where it peaked out at the last big peak. Now, the truck build, as I think just recently, was somewhere around 35,000 units. We don't think that 35,000 units on a sustainable basis makes any sense. So we're saying that at some point here that's going to have to temper back down. Unless they blow right past the last peak which was the last record they ever had in this business, which was 35,000 units back in the year 2000. So we're thinking that's going to temper, when? Sometime probably this fiscal year, our fiscal year is what we're projecting. But again it's still going to be pretty strong because the level of activity is still strong. It's just not going to be as strong we don't think as it is right now.

Okay. Thanks for the clarification.

Thanks, Jeff.

You're next question comes from the line of Joel Tiss with Lehman Brothers.

Hey, guys. Most of my questions have been answered. I just wondered if you could give us a little color on the top line strength in Europe? Where it's coming from, and just so we can understand because almost everyone else has been talking more flattish, and maybe a little sense of what's included in your guidance for next year.

Joel, this is Pam Huggins speaking. You know our 3 big countries are Germany, France and the U.K. and all of those are up right now for us. I think part of it is you know we consolidated our sales force in Europe and I think we're seeing some of the effect in that. We really think that Europe's going to kick in here, it's just at the beginnings of what we think is going to be a real come back. You know, we look around at all the countries and right now almost all of the countries, and particularly the big ones that we do business with, are all in a very positive standing for us.

And then just saying a little more clarification you say that they're just coming back ? Is that 1 month, or 3 months? And the currency, I guess is not hurting them?

We think in the last quarter it's been the strongest this year.

Okay. Thank you.

Your next question comes from the line of Robert McCarthy with Baird.

Good morning, everybody.

Good morning.

I'd like to ask about the aerospace business again, not to beat a dead horse, but, Pam, I think you I heard you say that fourth quarter orders were up 14% in aerospace. Could you tell us how that trended compared with the prior three quarters? Because you're up 15 for the full year.

I don't know -- I don't know if we have that right now, Rob, with us in terms of how it trended against the prior quarters.

Rob, I can answer that that a little bit. Aftermarket I know in the fourth quarter was up about 16%. I do know that. So you can probably work into the numbers using that ask kind of working backwards.

Okay. Well that's helpful. Maybe we can pursue that later. I'm interested, Tim, in your characterization of your underlying assumptions for this business. Because I'm looking at you know first 6 months of this calendar year domestic available seat miles running up in a 7, 8% range and you all were talking earlier about planes coming out the desert. So I'm not quite sure why you're outlook is so flattish for commercial aftermarket.

Well, again, Rob, it's -- there are planes coming out of the desert. You got to understand that a lot of planes coming out of the desert is are not going back into passenger service, they are being converted for freight.

Okay.

Some are going back into the passenger ranks. Either way it does bode well down the line for the aftermarket, so. And it's really a question of it's a timing type of thing. As people begin to fly again and you know businesses are encouraging the sales people to get out. I think people are feeling a little bit better about taking vacations and holidays and as this picks up that certainly will ultimately come through for increased aftermarket. We have not put a lot into the plan. I mean, you know we have put some in the plan, but not a lot. And we'll see how it plays out. You know, we could, you know, 3, 6 months from now we can find out that we have underestimated and it's better than we thought. We're not actually concerned that it's going to be less than what we thought unless there's a real disaster out there, another 9/11. We're not looking for that. So we have an increase. It's a very modest increase, and we'll just see on a go-forward basis. Again, no one really -- you know we don't really know.

Oh, I understand that. Let me ask you about then if I can for a couple small number clarifications details. Can you tell us what you're expectations are for capital spending and for depreciation and amortization in fiscal '05? And can you give us what the increase in your pension expense was in fiscal '04 to compare against the 30 that you believe it's going to go up in '05?

Rob, I'll take those questions if that's okay.

Absolutely.

Right now baked into the plans for capital expenditures we have 3.5% and on depreciation we have 3%. On the pension insurance and medical, I think you probably recall that we had said that it was probably going to be around 70 to 75.

Yeah.

And in fact it came in more around 50 to 55.

That's for '04.

Right. For '04.

What's the comparable number for '05?

In '05 we're expecting it to be somewhere in the neighborhood of 40 to 50.

Great. Thanks a lot.

And for those people that don't understand, that's what we call PIM. That is pension and insurance and medical all rolled into one.

Your next question comes from the line of John McGinty with Credit Suisse First Boston.

Tim, there's nobody left on the call that doesn't understand that at this point.

[Laughter]. Good comment, John.

Just a couple of quick questions. One in the North American Industrial, where your sales gain is up 6 to 8%, is there any acquisition in that?

No. No.

We stripped out those and we give it to you before and after.

No. The 6 to 8% -- you're talking about the guidance.

In other words is there any carryover from Dennison in that number?

Yes, there would be.

So what's the core business there?

That would be -- you're right. There would be roughly a half of year of that. Maybe $100 million, John, you're right.

In domestic?

John, --

Domestic is very small.

Yeah. Well, that's what I'm trying to figure out. I'm trying to figure out what the core 6 to 8 is.

My guys say they have it.

The growth due to Dennison, North America is 1%.

Okay. So in other words the 6 to 8 would be 5 to 7 ex Dennison.

Right.

And -- what about in Europe the 8 to 10. What of that is Dennison? What of that is currency?

5% is Dennison but currency isn't baked in there. It's excluding currency .

So your core forecast for the international is really 3 to 5 and it's 5 to 7 in North America on an ex acquisition or comparable comparable basis.

I would assume you're doing your math right and say yes. We're in agreement.

All right. The PIM, the 40 to 50, how much of that is baked into the operating pieces and how much of that shows up in the other?

Oh, I don't have that breakdown but -- I really don't have that breakdown because you know we're in -- from pension standpoint -- we're in a loss position now where you're amortizing -- you have to amortize those losses over 4 years. And that particular part stays at the corporate level and then the actual part that -- the employee part actually goes into the segment information. But I don't have that breakdown right off hand.

It would be helpful to get that because people are looking at incremental margins by segment and the extent to which the PIM number is going up or down, because you mentioned one the reasons that we get the increase of 50 to 100 -- 75 to 100%, whatever it is, sorry, yeah 75 to 100% in other, a piece of that is the pension --

Right.

--increase. So if we could get that off line that would be great.

Sure.

The third question is, it's a small number but it's a big jump. The other went from 4.5 to 9.5 million in operating profit --

-- And that's.

-- I guess my question is is -- and yet you've got the year -- next year flat. So does that mean that there's a seasonality or something has changed or was there something unusual? In other words, I'm not saying I want to annalize the fourth quarter, but when you get that kind of jump and I'm not looking for anything next year that just raises some questions.

Well as I mentioned during the prepared remarks, when's you're looking at that other expense line there's the -- gain on the sale of the business unit.

No, no. Pam, I'm talking in the Other reporting segment.

Oh, okay.

Let me yeah. John, let me handle this. Pam's mind was on a different track.

Sorry.

Yeah. No. That's okay. We have too many Others around here. What happened in Other, I think Don touched on this earlier a little bit in terms of what -- the wonderful thing about some of the Win initiatives is in bringing them to these acquisitions and seeing the good that they can do and they really have paid huge dividends in those business units. Now, so the improvements in the margin in both those units was our -- our sustainable good-forward and they're just things we've done on procurement and pricing and some lien things. So the anomaly, and I will tell you there is an anomaly in the margin in the fourth quarter and the Other at 15% is an anomaly. There was probably about a million dollars of sort of extraordinary profits in there, if you will, credits in there. We had -- we talked about legal reserves and accruals other places. This is a case where we were able to reduce some legal accruals and take that back into profits. So the quarter had about a million dollars. Without that they would have been like about a 13% ROS instead.

Yep.

And that was a legitimate margin in the quarter. And again it was also a good strong recovery quarter too. So.

But you've only got -- you've only got them going up I mean you've got them flat. They did 13% but you've got them flat to up you know up to you know 10.5%.

We're looking I mean again they had a huge quantum leap as you've indicated. Huge quantum leap and improvement on the margins. Yeah. We do have a question very modest improvement on the margins.

I guess the question is the seasonality? I mean there hasn't been historically, but is what's left in there, they make all their money in the fourth quarter or something?

Oh, it is very seasonal. The Astron [ph] business is very seasonal, because they're building buildings.

Then the last question and this is I don't know if this is a fair question, but what the hell it's late I'll ask it anyway. You guys had for a couple of years were a bit optimistic on your forecast. You kind of got your hat handed to you as the economy went the other way. You pulled into your shell and made a couple forecasts that were, like, incredibly conservative. What mode are we in are? Are we still in the head in the shell mode or you trying to stick your head out? I mean, how would you characterize your thought process as you make this set of forecasts?

John, we'd like to always exceed your expectations.

Okay.

That's our motto around here is we want to exceed your expectations.

Fair enough, Don. And listen great of you guys to be on the call. Thanks very much. Appreciate it.

Your next question comes from the line of Barry Bannister with Legg Mason.

Gentlemen, I know it's late. You cited your upside semiconductor but you wouldn't know it to look at Intel stock price or the socks [ph] year-to-date . Larger wafer sizes are resulting in excess inventory of chips and fewer runs in the future, so why would I view the future as being like the past for Veriflow or Finite or the seals business?

Well, Barry, this is Tim. We do not -- we do not really view the future like the past. Again I think Pam articulated. In terms of how we're going to run the businesses and how we've restructured them to build a lot more flexibility and adaptability into them. I mean which do think that it's going to be very tough for us to control the volatility in the market. You know, they seem to be that way. They you know and I don't know when that's going to change. But what we have to do is construct our business model so that you know -- we'll do well in the upside, but when it turns down, we can really moderate and we've done that by reducing our break even points, our fixed costs, and so forth. So that's what we're -- that's what we can do internally we can ride the wave when it's there and then hopefully contain any damage on the downside.

And on another product, Eaton talks a lot about their new light weight 5,000 PSI hydraulic system for commercial airliners, and since fuel economy seems to be more critical these days, is there any potential for significant share loss on your hydraulic specs for Parker Aero?

We also have a 5,000 PSI product, Barry.

So they were late coming to the party, or what?

I don't know who was first. Maybe Pam does.

We've had one for a long time. We've had a 5,000 PSI that was used in the the defense side of the business for a very long time. So this isn't anything new for us. I don't want to say they were late coming to the party, and I don't think it's fair for me to say that, but I would say that we've really been there for a long time.

I know the 5,000 PSI is on the defense side, but it is speced out for the commercial airliner?

We've quoted it on the commerce side. As a matter of fact, we have some quotes outstanding on the commercial side.

Okay. Great, thanks.

Again in order to ask a question please press star 1 on your telephone key pad.

Okay. Tina. I think we'll cut off at at this time if that's -- and I want to say thank you. I want to thank everyone for their interest in Parker Hannifin and Nick and I will be available today should anybody have any follow-on questions.

Thank you. This concludes Parker Hannifin Corporation's fourth quarter fiscal year 2004 earnings release conference call. You may now disconnect.