派克漢尼汾 (PH) 2005 Q1 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 the Parker Hannifin first quarter 2005 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.

Thank you. Ms. Huggins, you may begin your conference.

Thanks, Tina. Good morning, everyone, and I would like to welcome you as well to Parker Hannifin's first quarter teleconference. As is customary, I have a few comments prior to commencing with my prepared remarks. The slides that we will be using today will remain on Parker's website at PHstock.com until the next earnings release, along with the webcast of the teleconference itself. Upon commencement of Q&A to be held at the end of the prepared remarks, please limit yourself to one question at a time in order to give everyone a chance to participate.

At this time I would, once again, like to call your attention to the disclosure on forward-looking statements. A couple of minor changes have been made to the statement, so again I ask that if you haven't read this statement, please read it in its entirety. Also as is customary, the numbers that will be presented today are on a GAAP basis; however, there is one exception to that, that exception being sales. The sales numbers have been reconciled from a GAAP basis, so that without acquisitions and divestitures and currency, to allow for a valid comparison from period to period.

Again, while Power Point slides have been provided, I won't be reviewing each slide in detail. Rather, I will be providing the summary of the quarter only, focusing on the highlights. First I'll begin with the earnings per share results and the sales growth for the quarter. I will then have a few comments on order trends. I will then comment on influences to earnings including the WIN Strategy. I will briefly summarize segment results. I will then conclude with a quick overview of the balance sheet and cash flow position, and close with a revised outlook for fiscal year 2005. I am pleased to report today that after my prepared remarks Nick Vande Steeg, Vice President and Chief Operating Officer, will be joining me for the question-and-answer session.

At this time let's begin with the earnings release. In line with the press release this morning and well above previous guidance, first quarter earnings on a GAAP basis came in very strong at $1.11, 131 percent higher than earnings per share for the same quarter a year ago. Earnings per share for the quarter of $1.11 are above previous guidance of 70 to 80 cents and above the mean of 83 cents. This $1.11 would have been $1.18 had it not been for expense associated with an investment write down, and a pension adjustment as a result of planned restructuring.

Segment operating income for the quarter improved 500 basis points, moving from 8.5 percent to 13.5 percent. As a reminder I've chosen not to talk about realignment charges here. I won't be discussing them, as they have been reduced to an insignificant level and are considered normal operating expenses. Sales for the quarter were up 23 percent over last year, and of the 23 percent growth, 3 percent of the increase resulted from acquisitions, while 3 percent came from currency -- mainly the Euro, leaving 17 percent growth from our core businesses. Positive sales growth was experienced across all segments of Parker's businesses, with North America obviously being the highest. The 17 percent organic sales growth is the result of continued industrial end market strength in most major markets with continued significant activity in heavy-duty truck in the mobile markets.

Semi-conductor and oil and gas, while not as large as the two markets just mentioned, was also very strong in the quarter. Distribution and general industrial continues to gain traction. Aerospace sales, as you saw, are up 16 percent for the quarter. The nascent commercial OEM and after market business continue to show signs of recovery. While North America is the main driver of the sales growth for the Company, the hydraulic strength is worldwide.

Moving to the indicator of future revenues, looking at North America order rates first, order rates have been positive for 13 consecutive months, and for the quarter, orders were up 17 percent excluding acquisitions and currency. Moving to rest of world orders, again, have improved year over year for 13 consecutive months, and for the quarter, orders were up 15 percent, driven by increased orders in all regions. Asia Pacific and Latin America continue to be the highest growth regions; however Europe has been a positive factor as well.

Moving to climate and industrial controls, for the quarter while volatile from month to month, orders were relatively flat. However, this was anticipated and in line with expectations as previously communicated.

Moving to aerospace orders, aerospace orders were up 19 percent for the month of September, and for the quarter orders were up 17 percent, and this was against tough comparisons. While there is a long way to get back to peak levels, the traffic statistics, the load factors, the number of points coming out of the desert, the commercial OEM projected build rates, and the solidness of the defense business is encouraging.

I will focus more on earnings now. Segment operating income for the quarter is 95 percent higher than the same quarter a year ago. North America earnings are 178 percent higher in the quarter, and international earnings are up 112 percent. While aerospace, climate and industrial controls in the other segment didn't see percentage increases to the same magnitude year over year, the margins in these segments are relatively high. Aerospace had margins of 15 percent, climate and industrial control had margins of 10 percent, and the other segment with margins of 14 percent. The increased earnings in the different segments are due to increased volume, movements to low cost countries, and the WIN Strategy. We are now running higher volumes through less facilities. The results can be seen on the gross margin line, pushing up over 330 basis points. On a year-over-year basis, margins increased this quarter in every segment other than climate and industrial controls.

I mentioned the WIN Strategy earlier, and just to give you an update, the WIN Strategy is Parker's initiative with respect to strategic procurement, strategic pricing, and lean. As a result of these initiatives, the expectation was to add 6 percent to the bottom line -- 2 percent from procurement, 2 percent from lean, and 2 percent from strategic pricing. Of the 6 percent in savings, we indicated that 1 percent would be derived in 2003, 2 percent in 2004, 2 percent in 2005, and 1 percent in 2006. Over 50 percent of our spend is now locked in long-term agreements. DSI's for the quarter declined 12 days year over year, sales per employee increased 17 percent for the quarter year over year, plant and equipment is below that of a year ago, 57 million. I think we are in line in meeting our objectives. Operating leverage for the North America was 47 percent, increasing margins from 6.4 percent to 14.4 percent. While the leverage wasn't as high in rest of world, it was 28 percent, and margins increased 470 basis points from 7.4 percent to 12.1 percent. In aerospace the marginal return on sales was 30 percent, and margins increased from 13.2 percent to 15.5 percent. Climate and industrial control margins declined from 11.2 percent to 9.6 percent, and this decline is due to business mix and timing as a result of customer planned movements. Not material in terms of Parker's total numbers but significant in terms of their improvement, the other segment has improved margins from 10.1 percent to 14.4 percent, a 430 basis point improvement.

At this time I'll look to the balance sheet providing a brief summary -- cash at the end of September was 291 million, up from 184 million in June. Inventory, while up 5 percent year over year and sequentially, DSI is down 12 days from a year ago. Accounts receivable in relation to sales is flat year over year, and as I mentioned earlier, property, plant, and equipment is down over 50 million, and this includes the acquisition of Dennison. Shareholders' equity increased over 529 million from a year ago, and as you know our leverage is good -- the lowest it has been since before 1999. The debt to total capital ratio is 24.1 percent, and if you look at it on a net basis, it's 18.3 percent. We continue to have strong cash flow with over 160 million this quarter.

And at this time I would like to go over the guidance for fiscal year 2005. The percentages that I'll be providing are basically the percentage increase over fiscal year 2004. In North America, industrial is expected that sales will increase 14 to 15 percent. In industrial rest of world, the projection is 13.5 percent to 14 percent. Aerospace, 8 to 9 percent. Climate and industrial controls, 18 to 19 percent. Keep in mind that this includes the Sporlan acquisition that we just announced in October. And the other segment is expected to increase 8 to 9 percent.

In terms of operating margin, I will give that number to you in basis points. Fiscal year -- North America operating margin for fiscal year 2005 is expected to increase 360 to 460 basis points over fiscal year 2004. Industrial rest of world operating margin is expected to increase 240 to 290 basis points, again over fiscal year 2004. Aerospace margins are expected to increase 70 to 150 basis points. Climate and industrial controls, the projection is 170 to 220 basis points over fiscal year 2004. And in the other segment, 130 to 180 basis points.

Looking at the numbers below operating margin, corporate administration relatively flat going from a -1 percent to a +1 percent. Interest expense obviously expected to be down 7 to 9 percent as a result of lower debt. On the other expense income line, there is a large increase going from 150 percent to 170 percent. There are of the several reasons for that, one being there was a gain on the sale of business units included in fiscal year 2004 that won't be repeated in fiscal year 2005. There is also pension adjustment in there, the investment write off that we mentioned in our press release, and obviously some currency losses. So to summarize for you, the quarter outlook for fiscal year 2005 -- the second quarter is 85 cents to $1.05, and the full year range is $4.30 to $4.70.

While I won't be covering the forecast risk for you, you can read those from the slides. At this time I would like to preempt a question that I think I'll receive with respect to pre-announcing. What I would like to say on that is in the industry the most of heated debates seems to center around guidance and pre-announcing. As you know, guidance is currently provided on a quarterly basis, and we have a chance to update those numbers every 90 days. In addition we provide the orders to you routinely on a monthly basis. What I would like to say is that we will let you know if there are any material and significant one off items. It is our feeling that pre-announcing doesn't allow for full disclosure of all the facts. Typically, when the announcement takes place, all the facts are unknown, and the only option is to be qualitative. Being qualitative can lead to wide interpretation. It's our choice to wait until the quarter closes, and we can discuss all the facts with certainty and on the call for all to hear.

That's all I have at this time. I thank you, and at this time we will open up to the question-and-answer session. As I mentioned earlier, Nick Vande Steeg will be here with me. Thank you.

(OPERATOR INSTRUCTIONS) Your first question comes from Gary McManus from JP Morgan.

Hi, Pam, great quarter.

Thank you very much, Gary.

On the second quarter guidance, you did $1.18 if I add back the 7 cents of non-recurring. If I take the midpoint of your second quarter guidance, that suggests roughly a 20 percent drop in earnings from the first quarter to the second quarter. Why do you expect such a fairly big percentage drop in second quarter earnings versus the first quarter?

Well, Gary, that's a good question. I think if you look back historically at Parker's results, I think we always go down significantly first quarter to second quarter. Last year we didn't. Last year was pretty stable, but last year was an unusual year for us. Typically where we do to 48 percent first half, 52 percent second half, last year was quite different on that. In fact, most of our profits came from the second half even in spite of that last year. So so with the holidays that we have in November -- Thanksgiving -- and with the Christmas holidays, it's pretty typical for us to see low second quarter. So this really isn't anything atypical, I think, for Parker Hannifin.

Okay. Just to follow up, if I look at your -- what you expect the margin change to be by segment, looking at two of them. Let's take aerospace. You expect, I think, if my math is right, the midpoint would be around 13.5 percent, and in the first quarter you did 15.5 percent. So you kind of expect the same kind of -- I mean you expect deterioration in aerospace margins beyond the first quarter. And the same thing with international. It looks like your full year margins are -- you are suggesting is roughly 11 percent, and you did 12 percent in the first quarter. So can you explain why you expect in those two segments, deteriorating margins for the rest of the year from the first quarter level?

You know, it gets down to the fact that it's really like I said before the holiday issue. As you have the holidays -- you know, our second quarter has the most holidays, and what ends up happening is we don't get the absorption that we get in the other quarters.

But --

And it's a simple issue of just not being -- we are not getting the absorption. We are running at a lower level. And we always have lower margins in second quarter.

Let me -- the margin change you gave is on the full year basis. So I'm looking at what you expect for the next nine months versus the first quarter. If I recall, you typically expect the second half of your fiscal year to be seasonally stronger than the first half. So, again why do you expect aerospace and rest of world margins to be down for the full year compared to what they did in the first quarter?

You're right. You're right. If you look at our forecast and you look at what we have going into the first half versus the second half, there really, there is a decline forecasted in that. And that is the -- we really just don't know. I mean, we have six weeks of backlog going out, okay. We have six weeks of backlog. That's all we have to really be able to forecast. And at this point in time we don't have anything -- I mean if you look at our guidance, our full year guidance, we are going from $3.30 -- $3.70 up to $4.30 to $4.70; that's $1.00 increase. Okay? So even though the sales decline in the second half, it's not the same as it is in the first. There is a huge increase in the forecast for the full year.

Okay. I got it. All right. Thanks.

Your next question comes from Andy Casey with Prudential Equity.

Hi, Andy.

Good morning, Pam. Good morning. Very good quarter as well.

Thank you.

So if we could answer Gary's question another way, you only have six weeks of backlog, so are you kind of erring on conservatism at this point?

You may call it conservative. I'm not sure that I would call it conservative. I would call it -- it's difficult to say what's going to happen. If you looked at the order trends, and you look at where the peaks fall, and then you look out going forward, it's a difficult call. And I think the full year guidance is -- I don't think it's conservative. I don't think it's aggressive. I think it's what we really see moving out.

Andy, if I might -- this is Nick Vande Steeg -- if I might chime in here just to let you know we have a pretty robust policy with regard to how we move forward in dealing with all our A groups. Looking at the various markets that we represent, looking at the backlogs, and looking particularly at the next quarter and then at the full year. When we lay this out with all the various groups -- and they've been relatively accurate as we've gone along in the past year -- this is what we get. I mean this is a result of that activity, and so we are going with it.

Okay. Thanks.

Andy?

Yes, Pam.

This is Pam. I just want to chime in a little bit. In the first quarter we had 23 percent increase in sales. Okay? The forecast basically is showing a 19 percent -- once you work out the numbers, you are going to see that there's a 19 percent increase in the first half. The increase in the second half results in a -- you know, once you factor in the increase for the second half you still have 13 percent increase for the year. So it's not significantly off.

Just one more add on, if I might. You know, the management team is very pleased about the first quarter growth of 17 percent organic, 23 percent overall, and the operating margin record. But the 13.5 percent, we want to point out, is the second highest in the Company's history. Only one other time have we ever exceeded 13.5 percent. So, in a way, I mean, this first quarter, you know, we have had all the stars have been lining up. We are very, very pleased with it, but we just frankly don't believe that the second quarter based on the holidays and all the things that Pam has talked about and the markets that we are looking at. Now they are all very strong.

I mean our markets in the -- in North America, for example, we are seeing a little bit of softening in semi-conductor. We are seeing automotive as down about --in our CIC group down around high single-digit. Around the world we are seeing some slowing in China that's being offset. There's some slowing in ag and construction in China, but that is being offset by telecommunications and instrumentation, so that's going along pretty nicely. And then Europe, as you know, we've been very pleased. Our goal has been -- with regard to rest of world, 60 percent of that is made up of Europe, and our goal all along through a whole series of initiatives is to get our margins above 10 percent. While, as you might imagine, that's exactly what happened in the first quarter. So across the world and across our entire marketplace this has been a very, very nice quarter.

If I could do one follow up.

Sure.

Your incremental margins as you went through were just completely well above what I was expecting given that other companies are discussing raw material cost increases for their input costs.

Right.

Can you address, you know, how much maybe of revenue growth was pricing related or give a little bit further detail on how you're able to offset what others don't appear to be able to do at this point?

I will answer that. We have been very diligent with regard to both our strategic initiatives, which is procurement as well as the pricing side of it. And in that diligence, I mean what we have done on the procurement side is, you know -- and we've talked about this at lots of conferences -- is the fact that we've tried to put into place agreements that, you know, are lifetime agreements with companies. And so that we drop down the number of suppliers, and we try to secure raw material prices, and avoid any kind of surcharges or price increases. We've been relatively successful at that.

However, even though our procurement program is exceeding our expectations, there are a number of commodities -- raw material commodities that are experiencing huge increases in the marketplace. These are commodities that we use. The first one that comes to mind is cold rolled steel, where the prices have increased some 147 percent. Aluminum has gone from $70 to $93 per hundred, and that's a 33 percent increase. Copper pricing used in a variety of our CIC units has increased by 75 percent. The brass prices have increased by 33 percent.

So we are experiencing, even though we have -- we've done a nice job in the procurement side, we are experiencing some of these in the form of either a surcharge or a price increase. And we have been very active in terms of being able to see what our content is of those raw materials and to trigger increases both in the form of surcharges and price increases along the way. I think we've told you before that we began all this back in April and May. And in some cases we saw the movement in the marketplace, and while we had secure procurement contracts we began to work on these. We've continued to increase prices right on through the summer into September and October. We have price increases that we are working on today for the second quarter. So we feel pretty good about, one, our ability to hold down these raw material cost escalations and in our ability to pass them through. And so that, if anything, has not had a negative impact on our margins, and if anything possibly a slight positive impact.

Thank you.

Your next question comes from Stephen Volkmann with Morgan Stanley.

Hi, Steve.

Good morning. Question here I guess about your forecast a little bit. I'm kind of looking at the charts you've given us in terms of the monthly order rates, Pam, and clearly the comparisons get a lot tougher pretty quickly here.

Right.

And as I look at your forecast versus what you gave us three months ago, you have essentially kind of doubled your growth forecast in North America industrial and up in other areas as well. And yet I just heard you say you only had six weeks of backlog. I'm just curious why you think that North America, for example, can be up 15 percent on top of what was already a really good year last year and how you come up with that forecast and maybe give us a little comfort level there.

Okay. Okay. First of all if you look at last year, we were down. After the first six months, we actually, sales were actually down 1 percent. We gained traction in the third quarter where sales went up 9 percent and then the fourth quarter 15 percent. So we really didn't see any growth in North America at all for the first six months, at all. So even though things are getting tougher going forward -- obviously we are going to be up against some tougher comparisons, it's not our view that things are really going to fall off. We have no reason to believe that heavy-duty truck is going to change. Everything that you've seen on that -- the build rate continues to be strong and will continue to be strong going forward. We have no reason to believe that the mobile market will change as well.

Semi-conductor we do feel might weaken a little bit in the second half. We have some businesses, such as our filtration and our refrigeration businesses that continue to be strong, regardless. Even during the downturn those continued to be strong. There isn't any reason to believe that aerospace will be any different. In fact, coming off the peak, you know, if you look pre-eleven as being 100 percent, we went down to 65 percent, now being up around 75 percent.

Everything that you read on that including the statistics, the load factors, the revenue passenger miles, everything that you see suggests that that should be fairly good as well. So, you know, I know you asked about the North America, but when you look at our forecast in total, I think we have reason to believe that we should continue at the pace that we've seen. So, yeah, I mean it's kind of funny, some people think it's significant growth, and some think it's not, but I think that it's going to be a good next year for us.

Let me add on just another comment, if I might, too. So Pam has talked a little bit about the markets, and, of course, we are seeing this ongoing broad expansion in terms of all of our markets. But there's another side to this that we want to talk about just a little bit, and that's what the WIN Strategy has done for the Company, especially in terms of lean. What we have found is through this rather robust increase in order rate and in sales, our lead times have not increased at all.

If you go division to division across North America or across the world, for that matter, the lead times have not increased, and our on-time delivery is better than it was a year ago, and that was better than it was the year before. So our factories are really changed in terms of this one piece flow and in terms of how they, you know, how they are responding to the upturn, and we have anecdotal evidence that would indicate that we are picking up market share.

And so we feel as though, you know, we have not had any hiccups with regard to -- with our deliveries. There is no indication of that. We watched our past due line items, our past due days very carefully. And so it's been a very positive thing. I think one of the things about Parker Hannifin throughout the years, and we always felt this would be the case, is that when the economic recovery occurred, that we would gain market share. And we believe that that's happening today.

That's helpful. Can I just follow up a little bit? There's been a bit of a theme this kind of earnings season so far where other costs, for example, the one that sticks in my mind is bonus accruals, have been up a lot at a lot of other companies. I'm struck by as you raise your forecast this much, I'm guessing there's probably some impact on bonus accruals. Is that kind of in the numbers for this quarter already? Or does that come later in the year? Or are there even some other certain nonoperating expenses that we might expect to tick up as the year goes forward that might help explain some of Gary's original question?

Thanks for mentioning that we are all thrilled to death that we don't see a problem at all. The facts that bonuses are increasing. As a matter of fact there was a few units when we had a report out here about a week ago that indicated that they had to true up their accruals for bonuses. And so we want to assure you that we are ahead of that curve, and in our numbers includes the, those proper accruals for increased bonuses.

Yes, I think to follow up on that, the only way that the bonus accruals would go up is if we did significantly better than our projections. And then that would be, you know, a good problem to have because it would be offset by obviously the higher sales.

You are doing significantly better than the projection you gave us three months ago, right?

Yes.

We factored that in.

That's exactly right.

Thanks very much.

Thank you.

Your next question comes from David Raso with Smith Barney.

Hi, David.

Hi. Quick question especially with Nick there on the lean operating focus. Regarding North America, those margins were very strong in the first quarter. Back in the day in the late 90s when the revenue was very strong as we are seeing now, the back half of the year gave you your best North America industrial margins. But the guidance implies a little bit lower for the next nine months. I know the second quarter is weaker.

Right.

Was there something in the first quarter on mix that particularly helped the margin that set the bar so high for the first quarter?

Not really. We had great absorption, obviously, but we weren't building inventory, David. So you could see by the numbers that Pam gave you on inventory that we didn't build inventory so we weren't over-absorbing. As a matter of fact, the DSI, days supply of inventory, was going down. You know, with regard to -- with regard to North America, what is really pleasing to us is that we have been questioned a lot about our ability to get to 15 percent in North America. And we moved the year-over-year number in North America from 6.4 percent operating margin to 14.4 percent.

And so I think now -- I think all of you and all of us are certainly aware that the 15 percent from the very beginning was an achievable goal. There is still some mileage ahead for us. Like Pam has said, we are just beginning this (INAUDIBLE) 2005, and we expect that the WIN Strategy to produce two points of operating margin, and then again in '06 another one. And we think that's still achievable. It's really interesting in some of the articles that have been -- that I've seen in Wall Street as well as in the New York Times talks about maybe we are at the end of this productivity gain. But that's absolutely not the case.

You know, year over year, our productivity gain was 17 percent. And this quarter, the first quarter our productivity gain across the Company was 5 percent. So -- and we think there's a lot more to go and we look at where we stand on lean and where we stand on our entire WIN Strategy. We assess on a scale, on an assessment scale that we have, when we take a look at this, and we say for example in lean where we set today?

On a scale of one to five we are about a 2.1. That's a pretty tough scale that we have, but there's a lot of mileage left here, a lot of productivity to be gained and so we think clearly that the WIN Strategy is pushing these results, and there's more to come. So we can get to 15 percent.

It kind of reinforces the rest of year North American margin guidance is implied at 13.5 percent. So if it's not mix, and the productivity improvements are still in front of you, it seems like it's not a difficult number to exceed?

Well, as always --

David, you know, we do have -- we are going back to our traditional mix. Last year what ended up happening, you know, we have typically larger portion of our profits in the last half of the year, and last year it was exceptionally high. If you look at last year, you see that's not typical but we are going back to what I would call a more typical mix for this year. So there really is more operating margin in the second half. The other thing to keep in mind is that the marginal return on sales coming out of a recession is very high. So at some point in time that starts dropping off.

One follow up on the balance sheet. Clearly the net debt to cap numbers are implying -- especially you're still not doing much by way of share repurchase. So acquisitions have always been a big part of the story. I'm not sure if Tim is there as well, but if either one of you want to take the CFO hat for a second, can you give some color on what the pipeline is looking like?

Sure.

Let me talk a little -- are you talking about acquisitions, David?

That's correct.

Well, first of all, let's reiterate that following our plan that we've talked about all along of being number one or two in each of our operating groups, we have developed a financial discipline for looking at potential acquisitions. The strategic plan that we leave out in front of our people and told all of you about has us looking to acquisitions for -- in growth markets, acquisitions that are technology leaders, acquisitions that offer a global offering that we can expand. Non-cyclicality is a key issue for us. We are looking for those types of acquisitions. And those that are accretive. We've told you that we are looking for acquisitions strategically in automation, in our automation group, in refrigeration, in seal, in filtration, in aerospace.

And let me just comment, if I might, that first of all, the acquisition that we made at Dennison, we are particularly pleased with the way that has been integrated into the Parker Hannifin system. We have introduced them to the WIN Strategy. They have been able to put that into play, and so what we've seen, the integration between our trading locations and operating divisions and theirs have produced synergies beyond what we thought were achievable in the beginning.

The second thing I'd like to talk about -- and I'm going to get to in a moment to what we have in the pipeline -- but let me talk just for a second about the Sporlan acquisition. We believe the Sporlan acquisition to be the crown jewel of commercial refrigeration. We have worked on the Sporlan acquisition for a long, long time. Sporlan has excellent brand awareness. It's -- it has a noncyclical revenue stream. If you look at that over the last 30 years, it has a systems orientation, which is consistent with our strategy. It has 60 percent MRO, which we like a lot, the after-market. It is a technology leader. It's been basically in North America, and we can take it to a global -- expand it globally. It fits right in the heart of federal regulation with [Sear] ratings and the like, you know, that are pushing technology in terms of refrigeration. It is right in the heart of the environmental -- the whole green initiatives. We are working on that.

And, you know, the whole idea of refrigeration impacts every one of us every day. We are very pleased about Sporlan. We are in the midst of integration. We have now a fast integration cycle. We benchmarked over the last couple of years to make ourselves be able to integrate and realize some of these synergies more quickly. We have a really on-purpose program. Now, as it applies to pipeline, specifically, that you talked about, we have several companies in the pipeline as we look forward in terms of acquisitions. So you are going to see us in the marketplace. You are going to see us making announcements. These have to do -- are right on our strategy.

And the other part of the strategy is building the platform in Asia-Pacific. And we are very active in Asia-Pacific. We want -- we know that the infrastructure that will be placed, for example, in China, we want to be involved in that in a big way. So we have a lot of activity with regard to where we are going there. So I think as the year plays out, David, you are going to see us rolling out some acquisitions in all the areas that I just mentioned.

Are they more on the Dennison side or the smaller --

Well, I mean, you know, we like -- for example the Sporlan acquisition with regard to revenue size and the management it has brought, we like the management and the technology a lot. So you're talking about 150 million and 1,000 employees. That size is very nice for us to disassimilate into our culture, so it becomes a division of the company. It retains a lot of its autonomy and decentralization it had as a private company. So it fits right in our focal point. So that's the nice size. There are various other sizes, but that fits perfectly for us.

That was helpful. Thank you.

Okay.

Your next question comes from Ann Duignan with Bear Stearns.

I'm curious if you could follow up a little bit, the anecdotal evidence of market share gains. Can you give more color on that in terms of product lines or regions or what you believe might be happening out there in the marketplace?

Well, it's a great question, Ann, and we have got to be really careful. I mean from time to time people talk about market share gains, and what I said is our evidence is only anecdotal. There are lots of small players out there and there are a lot of folks that are having problems. We hear about -- I can tell you about in some cases in Europe, some lead times of some competitors that have moved out from weeks to months and now they are talking about six- to nine-month lead times. In those cases we have product available and within our normally stated lead times. We are getting those orders. But that's anecdotal, and it's too early to talk about real market share gain. We like to hear those stories.

Premiere customer service is the number one goal of our Company in terms of the WIN Strategy. And when we are doing that right, we know that we will pick up market share. And we believe that we are -- from the evidence, from the anecdotal evidence, from what we are hearing -- and we are -- all of us in management are out in front of the customer. So it makes us feel as though that's probably the case, but I can't be -- I can't state any numbers.

It's primarily Europe, and it's primarily driven by lead times or the perception that some competitors are not able to keep up with demand.

No, Ann, I believe it's true across the world. It really is. If we look at our on-time deliveries in North America as compared to lots of our competitors, and you are hearing about raw material shortages and so forth. We haven't had a customer that where we have had to stop shipment or something like that of their end product as a result of making these commodities available. So once again, the WIN Strategy and necking this down during the difficult times in terms of procurement, and getting the supply base down to the folks who have really can deliver and we are committed delivering to Parker Hannifin has worked out very, very nicely for us. So I don't think it's -- while I mentioned Europe as one example of a long lead time there are lots of other examples, and the folks with -- that can deliver quality parts on time, which is the heart of our premiere customer service, are getting the orders.

That would make sense. As a follow up in rest of world, you mentioned that Europe is picking up a little bit. The last time I was at the National (FLUPAR) Association meeting, several suppliers mentioned that actually Russia was consuming products and actually a driver of demand for western Europe. Are you guys seeing that? Are you seeing some demand coming out of Russia? Or is the European recovery more western Europe?

Ann, that's a really good question. What you always see in Europe -- the big three, UK, France, and Germany, are doing very nicely. So we are seeing a nice order entry in all three of those countries. Italy, it's softened. No question about it. Now when you start to move out to the Czech Republic and Poland, the order rate has been phenomenal. We have trading locations. We have a trading location, as you mentioned, in Russia and the order entry rate has been very robust. We are very pleased. And we talked about this on many occasions, the fact that we've got those locations. Some of you have visited them in the Czech Republic in (Sask and Kamitah), and now a couple of locations in Poland. And so we are using those for low cost labor, but we are also using those -- those locations and putting in trading subs to penetrate that marketplace, and that's gone nicely. The answer to your question specific is, yes, very nice entry in those former eastern block countries.

Just as a quick follow up, is it more mobile products or more industrial products that -- the industrial demands that you're seeing?

Tends to be more mobile.

More mobile. Okay. Thank you.

Your next question comes from Jeff Hammond with KeyBanc Capital Market.

Good morning, Pam, Nick. Wanted to hit the raw material issue a different way. Nick, you mentioned lifetime contracts with these suppliers. How does that play in given the inflationary pressures on the steel side and the fact that a lot of your competitors are seeing new contract prices starting into calendar '05? And then maybe quantify if there is any raw material headwind baked into your new fiscal '05 guidance relative to what you might not be able to make up in price.

Well, specifically, with regard to long-term contracts, when you are dealing with let's say a steel supplier, he has to pass along those increases. But when you have lifetime agreements, you are sort of the last guy to get hit. I mean you're not the first. And what he's doing is with regard to everything from the supply of those scarce raw materials to the pricing, you sort of have a leg up. But we are receiving, and I mentioned that. And we track very carefully exactly what the impact is. So we know, for example, exactly what the purchase goods, how much they are up quarter over quarter and sequentially and year over year.

So we know those numbers. And we know what we've got to pass along in the way of percentages to our customers. And so that's monitor the trigger points, as I mentioned before, are all in place. So we've been able to forestall them as much as possible. And when we take them and we've been able to move them into the marketplace. And we have been talking about increases to our distribution and to our OE customers. That comes in a form of surcharges, when that's the customer's preferred method of accepting those increases, and in the case of the price increases, if their technology, electronic technology doesn't avail itself to that. I don't know if I answered all of it. Maybe, Pam, you have another.

Yeah, I guess I would say, Jeff, in terms of the forecast going forward, we are not assuming that we are going to have raw material price increases that we cannot pass through for the most part. We do have exceptions with OEMs where we have to negotiate those one-on-one. But 50 percent of our business is through distribution where we can easily pass those price increases through. So for the most part if you're looking at the forecast, I would assume, that we are going to pass those through.

Maybe just one comment. I mean, as we have contracts that are lifetime contracts on raw materials, and because of the escalation of raw material costs, they have had to pass those along to us. In turn, when it comes to construction, ag, and transportation, for example, the automotive industry, while we might have contracts in place, we've had to go back to them and say, look, you know that these raw materials are going up, and so we've got to alter the contract accordingly. So what Pam has said is there is nothing negative baked in here with regards to the fact that we will not be able to pass through the raw material increases that we receive. There is nothing baked into these numbers as we go forward.

Okay. Then on aerospace, if you talk about -- you've talked about commercial aerospace recovery. Maybe talk about how that played into the mix versus volume and the impact on the margins. And then how you are thinking about the commercial recovery for the full year margin expectation, which, again, for a full year basis is considerably lower than what you had this quarter.

Right. Looking out at aerospace I think that we pretty much aren't changing what we've been saying that the past, and that's that commercial aerospace really isn't going to come back until 2006. We do see that the after-market is going to come back somewhat in 2005. So obviously we have some of that baked into the plan. But we are not forecasting a huge increase in commercial aerospace until really 2006.

Did it have much impact on the margins this quarter?

Well, the margins in aerospace went to 15.5 percent. So there obviously was a good mix of after market in this particular quarter. But we are not sure what's going to happen with that going forward.

Okay. Perfect. Thanks.

One of the things, Jeff, I might just kind of put a plug in here for investor day. On our WIN Strategy, on the far right-hand side of that talks about profitable growth. And really the Company, what we are saying is as we move toward -- everybody is working on operational excellence. And our WIN Strategy is clearly, as we have talked over and over again, focused on that. But we are really beginning to move the Company to the far right side of that WIN Strategy and talk about innovation. That will be the theme of our investor conference that we are going to have, and we would encourage everyone to come to that because we have a lot of things to say about innovation and where we are taking the Company. And I think all of you will like it a lot and you will see a forward look as to where we are going as a Company.

Your next question comes from Mark Koznarek with Midwest Research.

There's been some questions on some discussions about price, and I'm wondering, you know, you guys on a division-by-division basis increase the price at different intervals, but is it possible to step back, Nick? Especially -- you gave us a raw material cost index, how much key raw materials went up over the last 12 months. Is it possible to give us some sort of guideline like that with regard to Parker's actual price in key segments? For instance, if the beginning of your fiscal '04, we were at 100 index in your North American operation. Where are we now on average? And then how much price is yet to be realized in '05? How much increase do we -- has already been announced that we are going to get later on in the year?

Well, that's really hard to say, Mark. I mean, once again pricing -- strategic pricing is something that we've had consultants working with the company. What we found is that with this autonomous division organization that we have, when we began to take a closer look at it, we found that what we believed to be the case with regard to pricing just -- and it wasn't the case. And early out we talked to all of you and we said, the worst thing that can happen in this whole WIN Strategy as we did lean and procurement is that we were to capture two plus two, and then in pricing, when we priced based on cost, it would be two plus two minus four equals zero. We went over that about a year and a half, two years ago with all of you in a very detailed way.

We also talked then about the various quadrants of pricing and, you know, what we could attain as a Company, you know, by, you know, pricing, for example, legacy product differently. And as we rationalize products and see product life cycles, that we price those differently. At the very same time what was happening is that we began to get a better handle on the content of our costs as we moved toward what we call lean accounting or activity-based accounting and market-based pricing. So we just learned a lot more about what's happening out in the marketplace.

I know there was a lot of skepticism that says, yeah, you know, pricing -- what can you really do when you are dealing with OEMs and pass throughs? But listen, I mean, information is king. And when you have the data, and it's compelling data you can pass along these prices, and we have. And our field sales has been schooled in this, and in our divisions there's been an awful lot of training. So it has really served us well. It's a little bit of a bonus to us. We felt as though there was a lot of areas that we just weren't doing a very good job in pricing, and we found that to be the case.

We really never assumed that coming out of the recession that it would be that important to us, and it really has. It's been instrumental. And our pricing program -- once again, let me say this, as I mentioned in terms of lean, that on an assessment scale of 1:5 in lean we are only about 2.1. On pricing, we are not even that far along. There's a lot of road ahead. We don't propose to anybody or try to give the impression that we are experts in pricing.

We are just better than we were before, and we are able to understand what the, what market-based prices are, and we are able to understand a little better our mix and our legacy products. That may a bit vague. I'm sorry if it was. But that's sort of where we are at.

Well, does that mean your prices are up 10 percent year over year?

I can't tell you. I don't know the answer. I mean, in some cases, yes. In some cases, to mobile accounts we've had to increase our prices by 7 percent. It really depends, Mark, division to division, it depends on content -- on content of labor and raw materials and which raw materials and how -- so it's a very data-based activity. So to give a number is really -- it really doesn't do anyone any good because would it depend on whether we are making a brass fitting or -- or a copper regulator. I mean it all depends.

If I could just ask for one clarification, I think when you speak about your outlook for industrial, international that's $1.00 -- that's $1.00 increase, right? So out of that we have to strip out acquisition and currency. Has your currency assumption changed? It looks like your international outlook, if you look at just the base business, which your base increase last time was 4 to 6 percent? Now it appears to be 10 percent. Is that raw improvement in outlook, or is some of that currency?

When we give you our forecast numbers, Mark, it does include -- we assume that there's no change in the currency from the prior period.

(INAUDIBLE - Multiple speakers) the outlook from a quarter ago?

Right. We assume that it is stable.

I know you assume it's stable year over year, but you didn't change it from a quarter ago?

Exactly.

Okay. Thank you.

Your next question comes from Alex Blanton from Ingalls and Schneider.

Good morning. I also want to take up the question of pricing. It's just an observation about those lifetime contracts. You must be absorbing some of those cost increases you mentioned, or those very good suppliers are going to be out of business soon. So I was going to ask -- I had been planning to ask how much your price is up in total, but you just said you won't disclose that. But clearly it's more than most companies. To what degree is that a function of your on-time delivery? In other words, you go to the customer, say I'd like to increase my price to you 5 percent, but I can deliver on time and none of my competitors can do that, isn't that a fair deal? Is that what you're doing?

Alex, that's a good observation. First of all, I didn't want to imply that our strategic procurement program would cause any disruption with regard to our supply base. We believe that these are sound business people, and that we are in no way wanting them to suffer financially as a result of some kind of a long-term agreement. So when they come to us with the data, we are open to discussing with them exactly what will they need in their business.

But your second point is really a good one. Because the reason that -- in our WIN Strategy the reason that Parker Hannifin has premiere customer service is the #1 item is that we know over time that all manner of good things happen when you have premiere customer service. When you have short lead times, when you have innovative products that are delivered on time and are high quality products, you are considered a premiere supplier. And to those premiere suppliers go the market share, and ultimately they get the price increases. So your observation is exactly correct.

Thank you. Just one more question. You said you were 50 percent along on the goal on WIN Strategy. Which would be 2 percent for 2004 and 2 percent for 2005. The 2004 -- your margins were up in the quarter by 500 basis points. How much of that was from WIN?

Well, first of all let me talk about the WIN Strategy just for a second. When you think about the four-year period of time when -- initially when this was rolled out by our CEO he talked about it was a two plus two plus two, and the way it was rolled out, the best we could see is that it would be 1 percent, 2 percent, 2 percent, 1 percent. We didn't what about to imply to anyone that the WIN Strategy will ever be over. It's trite to say this, but with regards to lean or pricing or procurement, it's a never-ending thing. We don't think we will ever get there.

The WIN Strategy is a strategy that stands the test of time. If we are talking to you eight years from today we are going to be talking to you about the WIN Strategy. That just a part of the culture of the Company. But when you begin to play this in and say what piece of this -- it's a little hard to know this. Let me tell you that for example, in terms of lean -- when the productivity quarter over quarter is up 5 percent, and if you go back -- if you go back years ago in Parker Hannifin through the '90s, we were talking about we thought we had a great year if we had a 5 percent increase in productivity for the year. Now we are getting 5 percent a quarter.

You are saying sequentially.

Right.

Yeah. Exactly. So now would part of that is the WIN Strategy? Well, a great deal of it, because all the stuff that we are doing with regard to lean and so forth is starting to pay dividends. Now, we said let's not keep track exactly of every dollar of what lean is producing to the bottom line. Let's concentrate on this. Let's concentrate on inventories go down, service goes up, quality gets better. Productivity -- did I say productivity? CapEx goes down.

Let's concentrate on those metrics. And we know that with productivity going up and as we will just be able to bring this to the bottom line. That's exactly what's happening. It's kind of an interesting statistic, because I heard recently that -- from a very learned source -- that said that of Fortune 500 companies, only 1 percent is actually doing lean. Now it's probably the 60, 70 percent of the company's say they have a continuous improvement program, and they are moving toward operational excellence, but at the end of the day you have to go into these factories. And a number of visits that I have made with analysts, I say, really, the proof is in -- just go to our divisions and take a look and see if you believe that lean is making a difference.

Well, it's probably a big part of the job with recovery in the country. But just one final observation, that even the pricing situation that you described earlier as a result of lean -- so it's really kind of hard to sort out, isn't it?

Well, no. Pricing is really not -- I mean, they are all inter-related.

Yes, but you were able to get the price increase because you were lean enough to get the -- keep the lead times constant. That's what I'd say. Okay. Thank you.

Thank you.

Your next question comes from David Bleustein with UBS.

Good morning. Nick, I'm intrigued by the pricing and your comments that strategic pricing initiative would be ongoing. How many times can you go back to the same customer on even a different product and walk them through your cost structure and what it costs you to produce it and capture pricing from that same customer?

I just think what we have seen is that we have several divisions in different places with regard to their degree of knowledge of pricing. And the, this whole idea of the life cycle of products and being able to legacy price properly and to rationalize products. And as you're -- the tendency across industrial America has been that these products come toward the end of their life cycle, but there's no, there's no pricing that goes along with it. So I just think it's -- we believe that it's something that we will be working on forever. Does that mean that we are going to go to these customers and increase prices over and over again until there's no end to it? Probably not. But having pricing as a strategic initiative within the Company we think is very, very important, and there's a lot of companies that haven't put the proper emphasis on it.

Terrific. On the very margin if you can what have you seen in the last couple of weeks in terms of steel prices, rubber, some of the other commodities?

I don't know, on a week-to-week basis our procurement people could tell you exactly. I was giving you -- we have some charts here that look at own a month-to-month basis, but obviously we stay close enough to it. Some of these commodities were so important to us that, you know, if you are making a brass fitting, for example -- the range is from, with regard to raw material commodity, some of our divisions, they are impacted only less than 5 percent of their -- of the costs of goods sold would be raw material oriented. Other ones it's over 50, so it's really a division-by-division situation.

Thanks.

Your next question comes from Ned Armstrong with FBR.

With regard to your end market by industry, are there any laggards out there that you are seeing that you think are on the cusp of starting to improve?

Markets that are starting to improve?

End markets, yes, that have been laggards and may be starting to improve soon?

Mining. Mining is one market that seems to be churning up a little bit for us.

And, of course, as we have been saying is that our distribution is getting stronger and stronger. So that's been a very nice positive for us because, I mean, I think all of you know about the importance of distribution to Parker Hannifin. And it lagged at the OEM mobile markets, so that continues to move up in the after-markets. So we think that will go on for some time.

Okay. Thank you.

Your next question comes from John McGinty of CSFB.

Good morning.

John, you're always at the end there. You must wait.

I'm just slow. I'm just slow. Just a couple clarifications. You said last quarter that the acquisition impact in the guidance in North American industrial was about 1 percent, that industrial rest of world impact was about 5 percent, and that was all there was. A, are those still the same? and, B, what would the acquisition impact be in the CIC, which has gone from minus one to plus one to up 18 to 19 in terms of your guidance?

Well, I can tell you that in terms of CIC, John, we had said pretty much before that we felt that climate and industrial controls was going to be fairly flat for the year, as you recall, because of automotive year over year.

Yes.

So I think for the most part most of it is --

All of it is Sporlan, then?

Not all of it, but the majority of it.

Okay. And then what was the PIM (ph) cost, then? You had said it was going to be 40 to 50 million. Any change in that?

No change to that.

Okay. And then in the other, the 7 cents, do we dummy that back up to a pretax of 12 million? In other words, 120 times 7 cents and then taking that up at a 30 percent tax rate? Or what was the pretax impact of that 7 cents?

Oh, okay. It was nine -- about 14.

14 million pretax.

Yes.

Okay. And the other, if we take the midpoint of the other -- and this is the other down underneath -- underneath the corporate expense, which was up 75 to 100, now it's up 150 to 170 percent, and that's about a $20, $25 million increase. A chunk of it is this non-recurring. What are the other factors that are going up to cause that other expense to go up an extra 10 million bucks or so?

Well, there is -- pension is in there.

No, no, Pam, this is versus what your guidance was a quarter ago. In other words, pension you said wasn't the same -- was the same. The stuff a year ago was the same, so I'm just asking what's up.

That investment write off is in there.

Yeah, but that's the 14 million. 14 million of the 25 million is in there.

The only thing that I know that are in there, there's sales to business units that was included in '04, a gain.

No, but that's not new information. Right? In other words, we knew that last quarter.

Right. I don't know of anything other than the pension curtailment, the investment write off, and the sale of the business unit are the only three items, John, that I know.

Okay.

Okay?

All right. And then the final question is, Nick, I understand everything you are saying about how difficult it is to look at price, but our sales are up 22 percent. And if you don't have an idea of how much of that was price, 2, 3, 4, 5 percent, then how can you say with comfort that you recovered your costs? In other words, if you don't know what your prices were up, I mean, it just seems illogical to say that you got your costs up if you don't know how much your prices were up. Or am I missing something?

You're not missing something. We know very clearly what our costs were up, down to the last dollar. Okay? And we know in general what our price increases have been, and it's more than covered. And we just don't want to get into a great deal of detail. But rest assured that our prices have covered -- have well covered our raw material increases.

So even though -- and that's very impressive, by the way. And actually when you look at the margins, you would assume they would almost have to. But even though prices are continuing to rise of some materials, you are on top of that sufficiently that you are able to even stay at least on if not ahead of the curve, which is pretty impressive. But looking at the margins, that almost has to have happened.

I don't know how impressive that is. I mean --

Well, other people aren't. Let's put it that way.

John, what we are looking at is trigger points, and when we see it move and we know what the impact division to division that is on those various raw materials, it's not all that difficult for us to know exactly what that impact should be in terms of our margins. And we are committed to having better gross margins. I mean it's that simple.

Some of the things that are happening -- we are not just sitting here letting those price increases come through. Because we did use the procurement program, we are actually using our suppliers. We are going back to them and leveraging them. So there's a lot of things that are going on in the procurement area to control these raw material price increases.

But also I guess another factor that may differentiate you is that because, Pam, you keep talking about you don't have any visibility more than six or eight weeks. Can we assume that you don't have long-term contracts going out to your customers that do not allow you to escalate whatever costs come through?

Well, I mean I think I covered that before and indicated that there are some of those contracts out there, but frankly these are very unusual times and we've gone to those customers and said, look --

Even those you've said, boom.

Yeah. I mean that's the, and you know, interestingly enough, if you are dealing with, let's just take a for instance, a Caterpillar tractor, they know precisely what those commodities are going up, and they are seeing them themselves, and so the data is very evident, and we are work we work them with regard to content. And these are great companies, and they are reasonable, and we've been able to pass along those costs.

Great. Thank you very much.

Thanks, John. Can we take one more question? It's 11:15 now, if that's okay.

Okay. Your final question comes from Joel Tiss with Lehman.

I have two questions. One is just trying to get a sense on what David was asking about before. I know you're not going to tell us where you can get to in terms of operating margins, but can you give us any sort of guideline? You are almost at peak of cycle. We have been over this all the whole conference call about near term margins, but just longer term, can you give us a couple of factors that we can use to think about how much better this cycle you can get than you've been before?

Well, last year we indicated that incrementals tend to run higher coming out of a recession. You recall that we said that. And with the addition of the WIN Strategy, obviously this is a little harder to gauge. But as you saw we've obtained 60 percent marginal return on sales in North America and quite frankly with don't think that that type of incremental is sustainable. You can see for the first quarter that while sales went down, actually earnings increased from the fourth quarter.

So I think, you know, the incrementals in the first quarter, while they continue to do good, the latter half we run up against some tougher comparisons. Our goal is to get, quite frankly, to 15 percent margins. We didn't say that we would get there in 2005, but we did say that that's our goal to get to 15 percent. We've been there before in North America. We've been there in aerospace. The only place that we haven't been is rest of world, and as you can see rest of world we had 12.1 percent margin this quarter. So we plan to get to 15 percent over the cycle.

Okay. And maybe another way to ask sort of the same thing, where are your operating rates currently?

Operating rates? Can you paraphrase that for me?

Yeah, your capacity utilization.

Okay.

I think a year ago, where you were a year ago, where you are now.

All right. Okay. I think one of the things is that becomes a lot less relevant in the lean environment. It absolutely does. As we operate in a lean environment, it's very easy to add capacity, and it's very easy to delete it. You're operating with small machining centers, and it's just not the issue that it was. I mean to answer your question, I'd say that we are in the high 70s. But, you know, I just don't see that as being as relevant as it used to be.

That really is, we've talked about this at various conferences, and it seems like no matter who you talk to, the answer -- this is kind of interesting. A consultant pointed this out as he went around Parker Hannifin. He said while there are various different equations for dealing with capacity, the answer always tends to be 66 and two-thirds, about two-thirds capacity. It's a moving target, and under the lean environment all we can tell you is even under the robust economy that we have today, we've got space, equipment, and people available in our units, and so that we just don't have a problem. And to give a number to that and say at what point would you reach capacity, it's just not possible. And we looked at some very sophisticated equations that really deal with the lean environment. So we've got lots of capacity. We always say to our customers, bring on the orders.

So moving from sort of mid 60s a year ago to the high 70s and plus all the other factors that you mentioned wouldn't be an important component of the margin improvement that we've seen so far?

Absorption is much better, obviously, but I don't know if the 60s to the 70s is a good number. Certainly when we have the productivity gains that we've been having and we are absorbing our overhead the way that we have been, I mean a lot of that falls to the bottom line. We knew that would happen. Like Pam said, we've been very, very pleased with the marginal returns. We know those are not sustainable, and as Parker Hannifin, we have been saying all along that our marginal returns should be in the neighborhood of 30 percent.

Okay. Thank you very much.

Thank you, Joel.

Okay. I would like to that you thank you all, and I will be around today to answer any further questions that you might have. Thank you.

This concludes today's Parker Hannifin conference call. You may now disconnect.