派克漢尼汾 (PH) 2005 Q2 法說會逐字稿

Good morning. My name is Lisa, and I will be your conference facilitator today. At this time I would like to welcome everyone to the Parker Hannifin second-quarter 2005 earnings release conference call. (OPERATOR INSTRUCTIONS). Ms. Huggins, you may begin your conference.

Thanks, Lisa. Good morning, everyone, and welcome to Parker Hannifin's second-quarter teleconference. As usual I have just a couple of comments prior to commencing with my prepared remarks. The sites 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.

Again upon commencement of Q&A to be held at the end of my prepared remarks, I'm going to ask you please, and I say please, limit yourself to one question at a time in order to give everyone a chance to participate.

I would like to once again call your attention to disclosure on forward-looking statements, and I would ask that you read the statement in its entirety. Periodically we do update this statement, so I would ask that you make sure that you read it again even if you have read it before.

Again, as a reminder, the numbers that we will be presenting today are on a GAAP basis with one exception, that exception being sales. The sales numbers have been reconciled from a GAAP basis to that without acquisitions and divestitures and currency to allow for a valid comparison from period to period. The discussion agenda that I will be following today is pretty much in line with the discussion agenda of the past, and while the PowerPoint slides contain a lot of data, I won't be reviewing each slide in detail but rather I will be focusing on the highlights for the quarter.

I will 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 on earnings, including the WIN Strategy, and I will briefly summarize the segment results. I will then conclude with a quick overview of the balance sheet and cash flow position, and then I will close with the outlook for fiscal year 2005.

Once again, I'm pleased to report that I have someone accompanying me today, that person being Jack Myslenski -- it's a tough word to say some time -- the Executive Vice President of Sales, Marketing and Operations Support, and he will be joining me for the Q&A session.

I will now begin with the earnings release itself. In line with the press release this morning that I'm sure all of you saw, second-quarter earnings on a GAAP basis came in at $1.41, which is 200 percent higher than earnings per share for the same quarter a year ago. Now the $1.41 includes 47 cents from discontinued operations. Included in the discontinued operations is 1 cent actually from the operations of Wynn and then 46 cents from the gain on the sale of the Wynn Specialty Chemical Company.

EPS without these items obviously is 94 cents in line with our guidance given last quarter. Segment operating income for the quarter improved 380 basis points to 11.6 percent from 7.8 percent. Sales for the quarter were up 22 percent over last year; however, 6 percent of that came from acquisitions and 4 percent from foreign currency, mainly the Euro, so that leaves 12 percent growth from our core businesses.

Positive sales growth was experienced across all segments of Parker's business with the exception of Climate and Industrial Controls. I will talk more about Climate and Industrial Controls in connection with the segment data.

The 12 percent organic sales growth that you see is the result of continued industrial end marketing strengths. In most of our markets, heavy-duty truck, mobile, oil and gas, just to name a few, continue to be strong. Excluding the FX impact, which is minor for Aerospace, sales are up 12 percent. While North America continues to be the main driver of sales growth for the Company, Parker continues to see strength in all regions.

Moving to the orders, starting with industrial North America, you can see that order rates have been positive for 16 consecutive months. While the growth only shows 4 percent last month, that is up again 17 percent in the prior year. The other thing that you don't see there is that we do report order growth on a year-over-year basis on a per day basis. There was another day in the orders this year that if you add that back because of the way we reported the discounts, it discounts that extra day, but if you add it back, that is about 5 to 6 percent. Just in the way we reported, it actually discounts it. So when you are looking at the actual dollars, it does make a difference. And I just wanted to point that out.

Obviously going back, you can see that we are coming up again sales comparisons. 30 percent obviously is not sustainable; however, I do want to make sure that everyone understands that our orders were still strong.

In industrial rest of world, orders again have improved year-over-year for 16 consecutive months, and again we are coming up against some tough comparisons. If you look out, you can see that orders in rest of world versus last month 23 percent, 25 percent -- my point is just yes, we are coming up against some tough comparisons, and I ask that you keep that in mind.

In Climate and Industrial Controls, orders in this group tend to be lumpy as you well know. What you are seeing is softness in the automotive market. We have been talking about that for some time, and I think that looking at the orders it just bears this out.

Aerospace, moving to the Aerospace orders, I just want to remind you that Aerospace orders are reported on a 12-month rolling basis. Wild (ph) orders continue to be encouraging. We were up again some easy comparisons most recently. The 25 percent that you see is against an easy comparison; however, we do see the commercial OEM market coming back, and of course, that is encouraging.

Segment operating income for the quarter is 80 percent higher than the same quarter a year ago. North America earnings are 105 percent higher than the same quarter a year ago, and of course, rest of world earnings are 108 percent higher. While Aerospace in the other segment did not see these types of increases, their margins continue to be very strong. Aerospace at 15.2 percent and the other segment at 12.8 percent.

The increased earnings in the different segments are obviously due to increased volume. As mentioned before, we are now running higher volumes through our facilities. They are also due to the WIN Strategy. This can be seen in the gross margin line, pushing up over 290 basis points.

The results of the WIN Strategy can be seen as I just mentioned in the margins. However, CIC you do see softness in the automotive market that we have been talking about for some time. We continue to see reductions in DSI, a six-day decrease year-over-year.

And just to move to the segments, very quickly, I am moving through this pretty quickly today so that we can get to the Q&A session, which I think most of you are most interested in. But in North America operating leverage was 38 percent moving margins from 7.1 percent up to 12.2 percent. And then, of course, in rest of world, wild (ph) average was not as high as North America. It was 23 percent with margins increasing from 6.7 percent to 10.6 percent.

Aerospace marginal return on sales was very good at 40 percent, and margins increased from 12 percent to 15.2 percent.

Climate and Industrial Controls margins declined from 7.2 percent to 5 percent. Again, this decline is due to the business mix and the softness in the automotive industry that I talked about earlier.

In the other segment, please remember that we did divest Wynn Specialty Chemical in this quarter. The results have been eliminated from the fiscal year 2005 and 2004 numbers and have been included in discontinued operations.

On the balance sheet side of things, our balance sheet continues to remain very strong. At 12/31 we had 117 million in cash. While that is down from 291 million last quarter, it is the result of the acquisitions that we did. As you recall, we did Acadia, Advanced and Trilogy within that quarter.

While inventory sequentially is up, DSI is down six days year-over-year, and DSO is also down sequentially two days. Shareholder's equity continues to decline. Our property, plant and equipment, we continue to keep CapEx around 2 percent. Our financial leverage is 24 percent, and this is in spite of the acquisitions that I just mentioned. So our balance sheet remains very strong obviously giving us the cover that we need to grow our business going forward.

Cash flow continues to be strong at 353 million for the six months year-to-date. That is about 9.1 percent of sales on a year-to-date basis. So we are very happy with that.

Moving to the outlook for fiscal year 2005, starting with the sales -- now the numbers that I am going to give you are 2005 increases over 2004. In North America industrial, our guidance is 15.5 percent to 17 percent. That is versus previous guidance of 14 to 15. Industrial rest of world, 14 to 15.5 percent, again moving that up a little bit from 13.5 to 14 in previous guidance. The guidance for Aerospace, 8 to 9.5 percent, again moving that up from previous guidance of 8 to 9 percent. Climate and Industrial Controls, 18 to 19 percent. Of course, you have to remember that that does include Sporlan. And then in the other segment, 21 to 23 percent. Again just as a reminder when Specialty Chemical was out of that particular segment now, what remains is the Astron business.

Moving to operating margins, I'm giving this to you in terms of basis points, and again it is fiscal year 2005 over 2004. North America industrial will be up 355 to 425 basis points. Our previous guidance was 360 to 460, so a little bit of change but still pretty much in line with what we reported last time. Industrial rest of world, 240 to 340 basis points. Again, we just widened the range a little bit on that versus previous guidance. Aerospace is up 120 to 170 basis points. And, of course, for Climate and Industrial Controls we are projecting that it will be flat year-over-year.

Other again, it does exclude Wynn Oil. The Astron business is less, and that we are projecting to be up 550 to 600 basis points.

Moving to below operating margin, our corporate administration, you can see that we are projecting 5 to 6 percent increase versus fiscal year 2004. Interest expense down 7 to 9 percent and even in spite of the acquisitions that we did. Other expense is projected to be up 150 to 170 percent. If you recall, we have the pension curtailment numbers in there, along with the investment write-offs that we made in the first quarter. Plus, there was a gain on the sale of a business included in '04 that is not duplicated in '05. So that is the reason for the huge increase that you're seeing in other expense. The tax rate going forward we are projecting 30 percent.

Then just looking at the outlook for the third quarter, the range is $1.10 to $1.30 as disclosed in the press release this morning, and the range on our full-year guidance is $4.75 up to $5.15. You must remember again that it does include the 49 cents from discontinued operations.

Obviously looking at a forecast risk, raw materials price increases, while we are passing on raw material price increases, of course, it has always been a risk dependent on what happens going forward. We would like to see interest rates go up very slowly and in small increments for sure. The Aerospace recovery, the OEM commercial market is coming back. Semiconductor industry, which we had mentioned previously, and our thoughts are pretty much unchanged on that, that it is soft.

We do remain seeing heavy-duty truck stability. I would like to point out that even though we have these items on our forecast risk we are very diversified across markets, and heavy-duty truck does not represent a large portion for Parker Hannifin. So should the heavy-duty truck business not sustain itself, it is a small portion of our total business, but I do have it listed because obviously there are some thought out there with respect to that.

So I guess I want to open it up to Q&A at this point time, which is what most of you would probably like to get to any way. I do have Jack Myslenski joining me. I do apologize for my voice. I do have laryngitis, but we will take it from there and welcome.

(OPERATOR INSTRUCTIONS). Alex Blanton. Ingalls & Snyder.

Good morning. Last quarter when you reported you talked a great deal about the fact that you were getting all of your raw materials on-time from your suppliers and no one else was able to do that, and you described why that occurred. Because you had long-term agreements that you have been working on for several years and working on the supply chain. You were able to pass along -- so you did not have inefficiencies from that. You had a record on-time delivery, and your backlog had not extended. So you were able to deliver on-time and continue to do that when your competitors were not. And then because of views which are product of the lean strategy, you were able to raise your margins very substantially over last year and also gain market share.

Now could you bring us up-to-date on all of that for the second quarter? Has there been any deterioration in those -- that excellent execution, and if so where and why?

Sure.

This is Jack Myslenski. I will try to cover all of these subjects that you brought up, and I'm sure that there are other similar questions in regard to most of those areas. I guess, number one, raw materials.

When we take a look at raw materials and what has happened first quarter to second quarter, we are not seeing any significant increases over first quarter. Although we saw some fluctuations, and it really depended upon what commodity we were talking about. If you take a look at the graphs that we look at on a regular basis, some are going up and some are slightly going down. So there were no significant decreases. There was some fluctuations.

As we move forward, we have looked at the raw materials, and we do see some commodities with some increases coming, although nothing as significant as we experienced in the first half or the type of increases we have seen since last year.

On the pricing side, we continue to be aggressive in making sure that we are recovering our raw materials increases. We believe that we have got them in place. We believe that we had many of them in place in the first quarter. And, in fact, we were ahead of the curve a little bit. What was the third part?

Well, delivery. (multiple speakers) You are passing on all the cost increases unlike many companies, and then you're delivering on time unlike most companies who are not able to do that because they cannot get the raw materials on-time and they cannot get their production done on time. But you are doing that, so you are gaining market share because others cannot deliver on-time. I would like an update on that situation.

Well, I am real happy to say that being on the sales and marketing side that one of the things that I watch more than anything is how well we're servicing our customers. And actually our divisions are at customer service levels that we have never seen before. We're very very pleased with our customer service levels. Our backlog going into the second half is very strong, so the order entry is still good. Yet we are able to deliver and we are able to get raw materials. We have not had any major interruptions in being able to get products, and consequently I think it is driving part of our sales numbers, our ability to service the customer. So we are real pleased with what our divisions have been able to do on the production side.

Now commenting against market share. I prefer not to get into market share numbers, although I feel like we have made some -- we have had a number of success stories, but I'm not going to try to quantify what that is as far as market share is concerned. But I truly believe that customer service does drive our ability to grow the business organically.

Stephen Volkmann. Morgan Stanley.

Can I just dig a little deeper? I want to make sure I understand what is going on with your kind of other expense line, which was obviously a lot higher. I guess that is sort of what you have been talking about, that 17 million in quarter versus I guess 4 million a quarter ago. What is actually -- what is the delta there?

The biggest driver there, Steve, is actually the fact that it is the pension expense. You know because you amortize losses over a four-year period, you end up reaching the corridor. And what ends up happening is that those losses are being amortized now, even though our assets are going up and the underfunded amount is going down, you don't see that gain come back for a time period. So what is happening is the previous losses are being amortized, and you're not really getting the benefit of a gain.

Okay. So most of that year-over-year delta is the pension?

Yes.

Okay. And should we expect that to be fairly stable quarterly going forward?

Yes, we are eventually going to turn the corner on it, but it is not going to be for awhile because of the four years. But you know we did throw out before that we said the pension insurance and medical was going to be around 40 to 50 million. We still believe that incremental.

Great. That is helpful. And then on -- the one thing I noticed on your outlook that seemed to change is the corporate and administration outlook kind of went up quite a bit I guess.

You are right.

What is driving that?

It is a good and bad thing. It is obviously the performance-based incentive because as we have ramped up so have the performance-based incentives. So that is a good thing and also a bad thing. But that is the short answer.

Sorry to push you on this, but it does not look like you have really changed your full-year forecast much if you take out the gain on Wynn, and yet this corporate thing has changed quite a bit from the guidance in the last quarter. I guess I would have assumed that unless performance changed the incentives would not really change. Is there something I am missing?

No, it is basically some workers -- there is some legal in there as well, but it is monthly performance-based compensation and some legal accruals.

Gary McManus. J.P. Morgan.

If I look at the North American Industrial, just looking at the incremental margins, they were 38 percent in the second quarter and 44 percent in the first quarter. So can you talk about why the incremental margins deteriorated sequentially?

Well, I think you know, Gary, second quarter is always a tough quarter because of all the holidays. You have the holidays in November and you have the holidays in December, and what ends up happening is just the productivity schedule causes under-absorption. And so you just do not get the kind of incrementals in the second quarter.

Well, I'm doing it year-over-year, so that should take out the seasonality effect.

Oh, okay. I'm sorry. I thought you were looking at it sequentially.

Basically what I'm doing is taking second-quarter revenues year-over-year and then second-quarter profits year-over-year and then looking at the incremental margins there and comparing it with the first quarter. I mean there's nothing -- I think other people have been acting like -- do you feel comfortable pricing is fully recovering raw materials costs, -- I mean efficiency -- anything along those lines?

I think we are ahead of the curve on the first quarter. 38 is more our normal type of incremental as opposed to the 47 that we had in the first quarter.

Okay. Just one other thing. When I look at your look -- again, looking at North American Industrial -- how you change both the revenue and margin guidance for the year, you raised full-year revenue guidance, but if I take a midpoint, you lowered the margin. So what happened between the first and second quarter to cause you to be a little bit more conservative on margins, even though you are slightly raising revenue guidance?

Which segment are you talking about, Gary?

North American Industrial. Again, you were at the existing revenue growth --

But I think that is just rounding, because I am showing it being pretty flat.

Well, before you had margin improvement of 360 to 460. Now you're saying 355 to 425. So you have pulled in the high-end range, despite the fact the revenue growth, you expect a little bit more revenue growth this year.

But I think if you look -- if you actually look at the operating margin for North America, the previous guidance versus the guidance now, it is virtually unchanged in terms of (technical difficulty)--. The midpoint is virtually unchanged in terms of margin.

Okay. Maybe I'm nitpicking, but it is down a little bit. You had 460 as the previous high range; now you're at 425.

Yes. But if you really just look at the operating margin, the percentage-wise, it's like 1/10 of a percent.

Okay. All right. Okay. But there is nothing going on --

No, no. I think once you have time to work through the numbers you will see that. You know that is just -- I mean this is not decimal point accounting accuracy on this type of modeling, because when you're working with all the different segments and coming up with the ranges, it just does not work as perfectly sometimes as you would like. But I think from a macro point of view when you look at it, it is right on with the same quarter. It is the same as last quarter, within 1/10 of a percent.

Andy Casey. Prudential Equity Group.

Just I guess a bookkeeping question, the tax rate came in I guess around 29 percent. Your full-year guidance is 30. Was there anything different in the quarter that lowered the tax rate versus the annual?

That is a good question. Actually we are in the middle of a research and development tax audit project, and we have applied to the IRS for a change in methodology. As you know, the IRS, they changed the R&D rules in December of '03, and they dropped what was called "The Discovery Test." So we took on a study in fiscal year '04. Now what they are saying is sustaining engineering now qualifies.

So we expect similar results in '05 as well, where we will be entitled to a credit. You know it is baked into the rate calculation. If we get approval on that methodology, the credit could even be larger. So you know 29 to 30 percent, it could even be a little lower. But when we get to these discrete items and the way you bake it into the calculation, we prefer to be conservative until we know the actual ruling.

Thank you and then the second question is on Aerospace. You kind of indicated that the commercial OEM is picking up, which is in line with what we have seen out of some of your customers. But could you describe what you're seeing in the commercial MRO market?

Right. I think we have seen some uptick in the MRO side. We have talked about that most recently. But what you're seeing today in terms of the order growth is really on the commercial OEM side. So I would say that from an MRO side most recently it is relatively flat. And what occurs is because of the commercial OEM coming back. You know that sometimes goes out a long time before you actually ship it. And the other problem with that, it is the lower margin business.

But the encouraging side is that the passenger revenue miles are up, the load factors are up. I mean there is not anything to indicate that Aerospace is not really in a recovery here.

Joanna Shatney. Goldman Sachs.

Good morning. Could we just delve a little bit more into the outlook for the North American Industrial business just on topline? I know, Pam, in our conversation after the order rates came out, that December looked kind of flattish with November, which is seasonally better than normal. But can you talk about what you guys -- what that topline forecast of 15.5 to 17 percent growth rate applies to the second half order rates? Is there a risk that the order trends that actually fall into negative territories would come up against the 30 percent comps?

And a technical question before you answer that. Are the acquisitions in this -- so when we had strip out the acquisitions out of the 15 to 17 percent or not? I cannot remember.

Okay. In terms of orders, I'm glad that you brought that up because you know in my prepared remarks I tried to talk about that a little bit and probably did not do a real good job in doing that. But we are coming up against tougher comps on orders, and we cannot deny that and I don't think we should and I think we should all be aware of that. In fact, I want you to be very much aware of that.

What I had to say, though, is that can be a little bit deceiving when you're looking at these percentages year-over-year. You really need to go back a couple of years when you're looking at those comps because our orders are very strong today. Orders continue to be strong. Our backlog continues to be very strong. So even though those percentages are going down, it really does not reflect the true value of the orders.

So I'm glad that you mentioned that. We are going to get into some very tough territory going forward. In North America it was 30 percent May a year ago. Obviously if you have 30 percent growth in the month, you're not going good duplicate that again this year. You're not going to have 30 percent again. We would like to say that we would have that, but I think that is a little unrealistic. That type of growth is not sustainable.

So yes, you are going to see the numbers decrease somewhat, but it does not mean that we are still not operating at a very high level.

These are the good times at Parker I want to remind you. These are the good times at Parker. Orders are very good. All of our end markets continue to remain very strong other than semiconductor is a little bit soft and obviously automotive. But all of our other markets we still have -- Europe tends to lag North America. It is coming back. We still have industrial that is coming on strong. Implant automation is picking up. Oil and gas is very strong. Mining is strong. We see an uptick in Aerospace. There is not anything to make us believe that this recovery is about to end. We really feel that we are still in the beginnings of a very nice recovery.

Things in North America are pretty optimistic. The one nice thing that is happening to us is our distribution has been getting sequentially stronger. And like Pam mentioned, there are not too many markets that we are concerned about. I guess if there was one on the industrial side, it is semicon, which I think you and I have talked about before as a question mark.

Automotive, Pam mentioned, is the other concern that we have. But when we take a look at the rest of the markets, they are pretty strong. And as we look at North America, and although these are only part of the equation, we are seeing strength on both sides of the border as well. Our Canadian numbers are getting a little better. I was in Mexico just before Christmas with our distribution in Mexico, and it appears as if things are getting stronger there.

So, like Pam said, these are kind of like the good old days. Business is good. Orders are coming in from broad-based markets, and we're not seeing any slowdown in anything in particular.

I did not answer your second question. Are acquisitions in? Yes.

Since we have Jack, can he just do the similar outlook by business in Europe?

I would have been disappointed had you not asked. I was just in Europe last week, and the first thing I will say is I'm pretty pleased with our first-half results in Europe. A lot of our initiatives are taking hold, and not only are the sales getting better, but our margins have improved from previous years.

If I look at -- and I think the easiest way to look at Europe is look at the countries -- the UK still is somewhat anemic. That has been our toughest one. Part of that is reduced production, as well as companies actually moving.

The other location that has been down or country that has been down is Italy, and I am seeing some signs where Italy is slowly coming back right now. Other than those two, everything else is looking relatively strong.

Germany has been inching up. I'm not going to say it is booming, but it has been sequentially getting better. The real encouraging thing in the last two months is our performance in France, which up until now has been flat at best. We are seeing some improvement there. The Northern countries in general are very strong, primarily because of construction equipment and forestry, and the place where we are obviously seeing huge growth right now is in some of the Eastern countries, large increases in business in Poland, the Czech Republic and in places such as Turkey.

So I'm pretty optimistic with Europe right now. The numbers are good. I don't see any particular industry that would be going down. So I'm optimistic there as we go forward.

Jeff Hammond. KeyBank Capital Markets.

I wanted to ask about Climate and Industrial Controls, you know a big change there on the margin improvement. And you mentioned I think on a couple of occasions in your prepared remarks, auto weakness. So maybe if you could touch on what is the impact from the weak auto? And then has there been any change in terms of what you're expecting and anticipating for Sporlan because I thought that was going to be a big contributor to the margin improvement?

Right. You are seeing a couple of things there, Jeff. I mean if you take out Sporlan, you can really see the decrease in the revenue as a result of the automotive.

The other thing that you are seeing is this is really the slow season for air-conditioning and refrigeration. They really start building this quarter for their season. So you know coincidentally when we talk about the perfect storm, in a way that is what you're kind of seeing. Because not only is automotive down, but it is not the good season for the refrigeration and air-conditioning. And with all that under-absorption that is hitting as well, that is what you're really seeing.

You know we are not going to make all of that up, but Sporlan is a great acquisition. Strategically it is a great acquisition. You are going to see better numbers in the third quarter. Once you work out your guidance, you will see that the third and fourth quarters is projecting fairly good numbers for CIC. So Sporlan is strategically very good, and it is definitely accretive. And you will see, like I said, much better numbers going forward.

But I guess this quarter aside, I mean you're taking your margin improvement from, say, 200 basis points improvement to really no change. I mean is that --?

The automotive is just softer than what we really truly expected, and it has to do with margins on some of the business there, too -- the particular high margin business. Everybody closed down December 15th in many respects in that particular business, and some of our big customers within Climate and Industrial Controls they just shut down December 15th for the rest of the year. So you know we were not producing.

And then was there any change in terms of the inventory step-up hit for Sporlan or what your intangible amortization is going to be where maybe the margins are not as good going forward?

Well, the Sporlan name you know was worth a lot. The Sporlan name was worth a lot. So definitely on any type of acquisition you have those heavy integration costs in the beginning and you do have intangibles, but all of that was pretty much baked in. Really when you talk to CIC management and really dig down on it, it is pretty much just the real softness that we have talked about.

Ann Duignan. Bear Stearns.

Maybe we could talk a little bit more about Climate and Industrial Controls. Could you break out, Pam, specifically how much restructuring was spent in that business to integrate Sporlan this quarter?

No, I really cannot. I would love to be able to give you that number, but we don't break that now.

I know you don't separate it as a line item going forward, but can you give us any guidance as to how the restructuring -- are we past the peak of restructuring, or should we continue to see restructuring over the next few quarters? Can you give us whatever guidance you can on it?

Well, we usually on an acquisition -- I think we usually give ourselves you know many months to really -- but I have to go back to what I said before. And that is that this -- I don't want to say problem -- but what you are seeing in Climate and Industrial Controls truly is not the Sporlan acquisition.

It is continuing operations?

Yes.

It was the market.

Should we forecast Climate and Industrial Controls going forward then as a much more volatile business?

It has always been volatile. You can see it in the orders. When you look at the order trends, it has always been very volatile.

Now we are helping to take some of that out. As you recall, it is volatile because there is an automotive component to that, but that is one of the reasons for the Sporlan acquisition because we were more OEM-oriented and Sporlan is more aftermarket. So that was the whole reason strategically. One of the reasons for that acquisition is to be able to manage that volatility a lot more.

Okay and can you talk about the three acquisitions you did this past quarter, and tell us why we should not have expected a little bit of an earnings guidance increase if for no other reason but based on those acquisitions?

Sure. I mean we did not do for the most part large acquisitions. We did the Acadia acquisition, which was about 145 million, and then we did the Advanced acquisition, which was 20 million. And then, of course, we did Trilogy, which was about 6 million. And if you really look at the accretion as a result of those acquisitions, they were marginally accretive in the period.

You know as with all acquisitions, you do have costs that creep in in the beginning you know. You cannot avoid it. You're going to have costs that creep in. But they were marginally accretive. They will continue to be accretive.

The seal business, as you well know, the Wynn, when they did the Wynn, we acquired a couple of businesses. They were making 15 percent in the seal business. We acquired a couple of businesses that were making 10. You know, pretty much if you look at seal business today, they are back up to those high levels. So -- you know they really were not large acquisitions. Sporlan again was accretive as well.

Getting back to Sporlan, I had a chance to visit Sporlan in December and go through an operational review. It is a wonderful acquisition for us. There are some issues that we have in this quarter with the market, and part of that was sort of a double hit because the automotive went down and this is not the refrigeration season. When you have got the weather at 9 degrees, you don't need a whole lot of refrigeration or air-conditioning. And we just had a bad -- this was a tough month.

Looking forward, though, the Sporlan acquisition is wonderful for us. And hopefully it will take the volatility out of the CIC Group order entry because it is more on the industrial side of the business as opposed to the automotive. So hopefully we will see some of that fluctuation being reduced. But it is going to offer us a lot of opportunities out in the market in the refrigeration and air-conditioning markets.

The other thing, Ann, the second quarter is just a real -- it is a difficult quarter for Parker to really gauge because of all of these holidays and the under-absorption that comes through. You know, I mean I just stress that second quarter is an unusual quarter for us, and you know it is not indicative of the second half.

Well, yes, if you look at even the ISM order data, the ISM orders have accelerated most recently, which would be a positive indicator for Parker. That coupled with the fact that you have done a couple of small acquisitions suggested to us there will be more upside pressure to your guidance rather than what we perceive as basically it knocked a penny off offer guidance if you back out the gain on the sale. I guess what we are struggling with, is this just a very conservative guidance and you are just being very conservative as you have been in the past, or is there something we are missing?

Have you known us to be any other way? Not to make light of it -- I'm not -- but I think for the most part it goes back to what Don has said in the past and that is that we would rather underpromise and overdeliver. But I will bring you back -- you know this is a reality check always -- and that said, in the first quarter we did a $1.11, the second quarter we did 94 cents. If you look at our guidance, that implies that there is about $1.22 for the next two quarters. So --

This is a long game. We are not -- we did have a good quarter. We had a very good first quarter, and we are very positive about both where we're going in the second half. Maybe not as overly optimistic as maybe what you are, but -- and remember how we do this. We just pick the numbers and roll out the numbers from our groups, and there might be a little bit of conservative forecasting in there at the group level. But this is why -- I mean when you take a look at the numbers on the guidance that we have given you, it is pretty consistent with what we have performed the last two quarters and with improvement going in the second half and as you know we tend to be a little bit stronger in the seventh half than we are in the first.

I understand all that. It is just a little bit disappointing when you say your backlog is growing, all of your end markets are doing very well, you have just made three little acquisitions that are accretive, and yet it is not reflected in your outlook in terms of bottom-line. I think the market perceives that as disappointing. I will leave it at that, and we can talk off-line.

David Bleustein. UBS.

Good morning. Your comment on the orders was unclear. For North America are you telling us that because there was one fewer day in December of '04 we should add 5 percent to the reported order number?

Well, all I'm saying is that -- what I'm saying, David, is that we report the numbers as an increase, a percentage increase period over period on a per day basis. So when you do that, if you have an extra day in the current period, that gets discounted. So looking at raw numbers, it can be better than what it appears in the percentage just because of the way it is calculated.

Okay. So there was one more day or one fewer day this --

There was one more day in the current period versus the same period a year ago, but it gets discounted because it's on a per day basis.

And the orders that you are reporting to us every quarter are on a per day basis?

Right.

Okay. So 4 percent reflects the daily order rate in December of '04 versus the daily order rate in December of '03.

On a per day basis.

Okay. Let me hit that one off-line, too. Can you walk through the impact of acquisitions on your inventories and receivables?

I don't have that information before me. I don't have that detail. I'm sorry, but I just don't have that detail.

I will catch you later then. Thanks.

David Raso. Smith Barney.

Good morning. I'm just trying to understand the topline guidance relative to the order trends we have been seeing. If you look at the full-year topline guidance for North America versus what you have put up in the fiscal first half, it implies the back half of the year grows at 11 to 11.5 percent.

Right.

One question. Sporlan, if I remember correctly, is roughly about 150 million annualized sales. What is baked into the back half of North America from Sporlan, I mean just roughly?

Sporlan is in Climate and Industrial Controls; it is not in North America.

It is not in -- that is even more to my point then. I'm trying to understand that business, you have first-half growth of 22, moderating to 11 to 11.5. A slowdown but given the orders had been even slower than that of late, and obviously comps don't get easier, that 11 does not seem like a lay-up. While conversely to your international business, and we have heard the positive comments about Europe before and so forth from Jack, you have it going from 32 percent growth in the first-half to 2. And clearly some acquisitions anniversary, currency will not help as much, but even the core growth in the first half was 12 to 12.5, and the orders have been strong.

Let's take the international. It does not make sense on a conservative fashion, and North America does not seem that realistic given the order rates and the order rate get harder.

Right. You know the only thing that I can say to you with respect to that is that we are coming up against tough comparisons.

Well, that is to my point. North America, that is tough comps, make 11 percent. Specialty is not much acquisition help, and obviously it is not much currency help. Given the order rates, that does not seem that easy. But then international, your core growth has been doing low double-digits. (inaudible) gets no help from acquisitions --

That is a good point. I think what you are pointing out is a good point, and you know we noticed that as well. But again I go back to the fact that it is a rollup from the divisions, but your point is well taken.

No, I understand. But obviously, Jack, you have got to go back to your operating people and say, help me understand. Is there a slowdown coming internationally on the topline that the order rates are misleadingly showing us that if anything an acceleration (inaudible)?

But I think you need to go back to the macro numbers. When you go back to the macro numbers, I want to reiterate that we did $1.11 in the first quarter and 94 cents in the second. And with our guidance, you know you can nitpick a little bit between segments. But with our guidance, it implies $1.22 for the third quarter and for the fourth quarter. And I think that is what is essential here.

I'm not trying to push the issue, but with Jack sitting there, Jack, what is your response --?

You are probably right, David, on the international side.

That there is --? (multiple speakers) there is a top line slowdown, or --?

No, it is like on the numbers that we have given you on the guidance side. The places where I would be concerned, if there are some downsides to this, would be if in fact there is any type of slowdown in Germany, which is a big portion of our business, and like I said, that one has been moving up slightly. And the other point would be if there is anything that would happen in China that would slow our growth rate down there, and there has been some movement by the government to try to slow down some of that growth. And we have seen some slowdowns in certain product lines, but we picked it up in others.

But to your point, yes, if you want to get into every one of the numbers, the international industrial is probably a little light.

And on the flipside, North America, why should I back in 11 percent topline in the back half if order rates are running slower and it gets more difficult?

Well, part of that hopefully the shipments will grow partially because we're rolling out our backlog. Our backlog is at the highest level -- I think the highest level we have got it ever.

And a lot of it is in North America.

A lot of that is in North America.

So your backlog can carry you in the back half of the year even if the order rate --?

On the sales side, yes.

John McGinty. CSFB.

A couple of clarifications. The change in the North American -- the three acquisitions that totaled about 175 million, how much of the increase in the guidance -- you had told us before that in industrial North America 1 percent of the guidance and 5 percent of industrial rest of world was acquisitions. What has that changed to with the new acquisitions?

I don't know. I know that Octavia is about a 60/40 split I think, Advanced I think is about 95 percent North America, and Trilogy is North America.

And those are all in industrial?

Right.

Okay. So most of the increase in the guidance between the 15.5 to 17 versus the 14/15 much of that is the acquisition?

Exactly.

Just a clarification. If we take the midpoint to midpoint, you're bringing the Climate and Industrial Controls down about 15, 16 million. This is the operating income midpoint to midpoint for the year-old guidance versus the new guidance. Is all of that the reduction in the auto, or is it, in fact, auto even more than that and Sporlan better than you thought?

No, I think Sporlan is pretty much what we thought -- it did pretty much what we thought it would do.

Okay. So all of the reduction is auto?

Right.

And then, Jack, you had mentioned earlier when we're talking about the incrementals in industrial North America, the 47 down to 38, that the 38 was more norm and the 47 was kind of everything went right for you. Could you talk the same way about the industrial rest of world where we were at 28 percent, which was one of the finer incremental margins we have seen over there. We're down to 23, which a couple of years ago we would have been thrilled with. But you know the bad news is now that you do well, people begin to look at it.

Where are we? Was that just kind of an anomaly? The same sort of thing? Where do you think those incrementals go in the balance of the year?

I think, John, you saw the same thing in North America that we saw in Europe. There was in both cases the incrementals were slightly higher than where we have been, with the 47 and the 28 in industrial international, and both of them dropped off slightly during the second quarter.

I would suspect that the more normalized number is what we saw in the second quarter as opposed to what we saw in the first quarter. We're very aggressive with pricing in the first quarter. Actually we were out there early on the street at the end of last fiscal year getting ready to increase our prices.

We got a lot of that in the first quarter, and some of it was before we even saw raw material price increases. And, therefore, we got some incrementals that were stronger than what we would typically see. The price increases went into effect. The raw materials prices went into effect, and I believe that what we saw was a more normalized incremental in the second quarter as opposed to the first.

Going forward I'm hoping that what we can achieve is essentially what we did in the -- more like the second quarter, and overall a combination of the two was around our 30 percent incremental number that we typically would (inaudible) return on. So I think there was just a little more normalized.

Martin Sankey. Neuberger Berman.

Okay. I guess lots of my questions have been answered, but I would still like to have one clarification with regard to the tax rate. You moved it down from 31 to 30 percent. You mentioned the R&D tax effect. Have you made any decisions regarding the latest tax act and how that might affect your tax rate going forward?

Yes. In terms of -- you know in terms of losing the (inaudible) I think is one thing with respect to that. There is a couple of things that are running around here in connection with the tax bill. We really think that we will lose a little bit on the tax rate with the (inaudible), but we think we will gain on the manufacturing deduction. So I think our view is that in the near-term it is going to be fairly neutral.

Will there be any effect from repatriation of received cash?

That is the second one. Good job there. The second thing I was going to mention that unfortunately for Parker that will not be any benefit from that, and let me explain why. Because the only companies that truly are going to benefit from that are companies that have a presence in tax havens such as Ireland, etc.

We don't have a substantial amount of low tax earnings overseas. We have always used adequate tax planning to make sure that we don't pay tax on foreign dividends. So we're not going to really see a benefit on that, but I do just want to reiterate that we're constantly working on the tax rate. That is what our tax department is paid to do. And we do get discrete items that are beneficial to us. The problem is you have trouble backing that into your rate going forward until you really get the ruling that the discrete item is okay. So that is where we stand. But that is a good question. Thank you.

Okay and I have one other question. You have spoken how the second half should average about $1.20 per share. I'm kind of new to the company, and it seems to me that there might be some seasonal effects which the past couple of years have been so volatile from a macro perspective that might be --. Could you talk to what might happen to your company under a normal circumstance between the third and the fourth quarter?

Yes. (multiple speakers). Typically the fourth quarter is a little better for us. But there have been times when the fourth quarter hasn't been. So it is hard to say.

But typically what you will see is the first half we will do about a 48 percent and the second-half 52 percent. I mean that is under what I would call a typical normalized year. Things have not been so typical in the past few years. Things are coming around to being a lot more typical now. So yes, I would say for the most part the fourth quarter is a little better than the third, but it has not always been that way.

Okay. And you don't see anything unusual happening this year that would disrupt what you were perceive to be a normal seasonal pattern or version to normal?

No, I really don't see anything right now that would indicate that there is anything that would make that different.

Okay. Thank you.

Joel Tiss. Lehman Brothers.

Just real quick. Two related. Why was the working capital up so much, and can you talk about your forecast for 2005 free cash flow and if that has changed at all?

We don't really give a forecast for free cash flow. You know I think when you look at the CapEx standpoint it came in I think about 2 percent. So really on a go-forward basis, even though we say that is going to be 3 to 3.5 percent, we have not really seen that start to ratchet up like that. I think it will get higher in the second-half than what you're seeing in the first half.

Our goal obviously is to have 10 percent operating cash flow. I think on a year-to-date basis we're at 9.1 percent. I don't see anything that would change that. We really have not forecasted cash flow, but I don't see anything that would indicate --.

You know one of the things, though, that you do have to think about is from a working capital standpoint -- is that in this inventory reduction program with Arlean (ph), etc., you do get the low hanging fruit in the beginning. In the beginning once you implement a program that inventory can come down pretty substantially in the beginning. And so it is difficult to sustain that type of reduction.

So that is something to keep in mind. But other than that, I don't think there is anything else that would be abnormal or unusual.

Okay. Thank you.

Does that answer your question?

Not really, but it is okay.

I'm sorry.

Ned Armstrong. FBR.

Good morning. I just had a small classification question. Regarding the 16.8 million in other expense that you show below your segment breakout, in your guidance going forward on this segment, is that pension portion of that other expense, which I'm estimating to be about 12 million? Is that embedded within the margin forecast that you are laying out there, or is that a separate item?

Can you repeat that question? I'm sorry.

Yes. On the segment operating income breakout, you have a separate line for other expense, 16.8 million, and a good portion of that, roughly 12 million (multiple speakers) is the pension. And you said you expected the pension, that type of level to recur at least for the next few quarters.

Right.

Okay. Is that recurring item embedded within the segment margins on a go-forward basis?

Yes.

In your projections for the remainder of '05?

No, no. That is below the segment. That is below segment. No, it is not embedded in there now that I understand your question.

And is that part of the corporate or part of the other?

It is part of other, but you have to remember that when you look at the consolidated statement of income, it gets embedded. It gets moved up in the cost of sales and SG&A.

Got it. Okay. Thank you.

Alex Blanton. Ingalls & Snyder.

Just a follow-up to this question of the amount of order increase year-over-year. You confuse people when you say that gets discounted. What you really mean to say I think is that you have to add 5 percent to the 4 percent to get the number, the absolute number, the increase in the absolute number rather than the per day basis. Is that correct?

I'm saying yes, the 4 percent has been discounted for that fact, so you are correct.

Well, if you just work it out, it comes out to you adding 5 percent.

Right.

If you have 22 days this year and 21 days last year in the month, that would add almost 5 percent.

You are right.

So why don't you adjust your orders for that? You adjusted for currency and you adjusted for acquisitions. Why wouldn't you not adjust it for number of days?

Well, we do adjust it for number of days in the fact that we report it on a per day basis.

No, no. I mean why don't you just report --

Actual number?

The actual number rather than divide by the number of days, because isn't that what we are really interested in?

Yes, I'm sure. But you know, we are just trying to find a method that works for everybody at all times.

Well, give us the number of days in each period then, along with the percentage increase, and we can make our own judgments.

Right. Well, there definitely is a couple more working days in the second half. That is that 48/52 that I talked about because there are a couple of working days more in the second half versus the first half. You are right. So thanks, Alex. I appreciate your comments.

Now, one other thing. You mentioned that margins were down quarter-over-quarter, and some of the incrementals if you figure out quarter-over-quarter were pretty bad. Because you had days that you were not reducing, so you under-absorbed the burden, what were the production days in the quarter versus the prior quarter? How many?

I don't have that level of detail before me, Alex, those production days.

Okay. Well, did your inventory --

I know that quarter-over-quarter -- well, I can just tell you that for first-half versus second-half working days, there is two more working days in the second half versus the first I think.

Yes. The seasonality is a more of function of the demand rather than the number of days, but I'm just trying to get an idea of what the magnitude of the difference in the number of production days because clearly if you produce less and sell the same amount you are going to have a big negative effect on earnings from under-absorption. But how much that was depends on how many production days there were.

A lot depends on it varies by group by group. It would be very hard for us to put a number on that. I mean it got down to differences within operating units even within some of the groups, especially at Christmas time and Thanksgiving. So it would be very difficult for us to put a number on the production days that were worse and (inaudible).

And really the only point that we were trying to get across is that, in fact, orders are still at a very good level. That is the macro point.

Yes, they are up 9 percent in the month of December, not 4. Okay. Thank you.

Mark Koznarek. Midwest Research.

A quarter ago the full-year outlook was $4.30 to $4.70. What kind of Wynn's operating income contribution in cents per share were you forecasting for the full year, you know what has now been pulled out of your continuing operations forecast?

I think you can pretty much assume it was 3 cents for six months. I think you can pretty much assume that that is a standard rate.

Okay. It is not very seasonal then.

Right.

Jack, you mentioned that there was real healthy price increases at the beginning of the fiscal year, and then the beginning of the calendar year is usually a traditional time for other price increases. And I'm wondering if you can quantify on average how much things went up effective January 1 and compare that back to the July 1 increases?

Typically around the Company we raise prices almost across the board July 1st. And that is typically to our distribution, that is the time period. We tried to get -- many years ago we went back and tried to get consistent because a lot of our distributors have many of our product lines as you know. So there was a concerted effort and always is in July to send out price increases with distribution.

Going forward in January it is more selective. We do have groups that are going up. We have groups that are going up in North America, and we have groups that are going up in Europe. It is not going to be as broad-based as the increases we saw in July, which is our typical time for it to increase at our distribution.

On the OEM side, we have been working with our OEM customers through the whole first-half, making sure that we have got the surcharges in place and/or price increases whichever to cover our raw materials costs, and again those will be selected going into the second-half depending on raw materials. So in a nutshell we have probably got more of our pricing in place in the first half than we will get it in the second half.

Sort of like a factor of 2 perhaps, or is even less than that?

It is probably less than that, but I really don't want to put a number on it.

Okay. But the OEMs I would imagine are more of a calendar year phenomenon. And so we might see more OEM activity effective January 1st?

Well, we've got a lot of our -- we did a lot of our pricing with the OEMs in the first-half. The thing that we got in place with many of our OEM customers are surcharges. And as we go forward, we will be adjusting for those surcharges as the raw materials increase. We don't have any major plans for going out across the board with major increases at our OEM customers.

Okay, great. That is helpful. Thanks.

Stephen Volkmann. Morgan Stanley.

Just a quick follow-up. I wanted to ask a question on the Aerospace business because there I think we are looking for higher margins now than your previous guidance and yet you have made some comments about the mix shifting more toward OE and away from aftermarket a little bit. I was just wondering if we could flesh that out a little?

Well, I think you know MRO continues to -- you know it is staying pretty level is what I said. And a lot of it depends on development costs in connection with the 77 and the 8380 and where those development costs really fall. So that has a little bit to do with it, Steve.

Okay. But should I assume, though, that as the mix shifts towards OE that that is not helpful to the margin or maybe I am wrong about that?

No, I think you're right. I think you're right. But you know, again we have given you some guidance on that, and I think that is relatively good.

Okay. How about the military side? What is your expectation for the rest of the year there?

Yes, I think that's going to be pretty level for us. I know there is a lot going on from a macro point of view on that, but I think from our particular point of view military will still be good.

Was the Aerospace margin -- it was a lot better than what I had in my model for this quarter that just ended. Was it a surprise to you as well?

A little.

And what was the driver there do you think?

Again, I think it just goes back to that development cost and where they fall in what period, and you know, some reserve adjustments -- that type of thing. It just came out a little bit better than what we expected.

Is there any guidance you can give us with respect to when these development costs will start to be more meaningful? Is that '05 or '06?

I think the best way that I can answer that is just to say that I think the guidance that was given is pretty good and I would pay attention to that.

Great. Thanks.

It is not answering your question, but it is my best at this point.

I will take what I can get. Thank you.

Andy Casey. Prudential Equity Group.

Just a quick question on the pipeline for acquisitions. If you could comment qualitatively on what you're seeing?

Sure. Good question.

I will comment. You saw that we made the three acquisitions in the first half. We continue to look at acquisitions. We will continue to look at acquisitions that are only in our space, things that are both onto the company and what we know in the Motion and Control area.

There is a lot of activity. The things that we will be looking at is not only product line extensions but also technology extensions on acquisitions, as well as geographic expansion. So we are going to continue to be active.

I mean the one thing that we are very pleased with is our ability to generate cash because it is the ability to make acquisitions. We will stay within the product lines that we are strong in. You know that one of our ongoing goals is to be number one, two or three. Number one and two in all of our product lines, and we want to be number one and two in all the regions of the world. So our acquisitions will be built around those goals. But yes, we will continue to be out in the market looking for opportunities.

Just a follow-up, Jack, if I may. In terms of the pipeline of activity that you're currently looking at, is it as strong as it was going into the fiscal second quarter, or has it decreased a little bit due to the acquisition activity that you closed in the second quarter? Thanks.

I don't think it has a direct bearing on what we did, but I would suggest that the activity is pretty high. And I think what we're seeing is maybe a little more activity than we did going into the beginning of the fiscal year. It has no bearing whatsoever on what we're doing. I just think that there is more possibilities out in the market right now and people are looking at whether or not they should divest or not.

Okay, go ahead. Jack, do you have another questions or answers?

I just want to make a general comment to everybody that is still online. We're pretty pleased with our second quarter. We did hit essentially the midpoint of what we put out there at the end of the first quarter. I know it is slightly less than what many of you had us at, but we're pleased with the fact that we did hit our number.

We did have a very good first half when you make the comparisons against where we were last year. Business is good. Order entry numbers have been good. I will caution everybody going forward that the comparisons are getting more and more difficult, and please when you get our charts on the seventh day of the month and you take a look at what happened -- or the third day of the month -- take a look at what the percentage increases were on the previous year. We are very committed to the WIN Strategy.

One of the things that we did not talk a lot about today is we still have ongoing programs in the three strategic areas. We are spending more time on the strategic pricing side in Europe. We continue to work diligently working with our vendors on the raw materials side, and all of our lean initiatives have not come up. I mean we are not done with that.

We are actually not done with any of our strategic initiatives as we are going forward. This is a long journey. And again, it is a long game. We think that we have done well, and we think we have ourselves positioned going forward. So we are pretty positive with where we are at, and we feel comfortable with the guidance that we have given you and we're looking forward to a pretty strong second half.

At this time, I would like to thank you all for your time and attention. I look forward to talking to you throughout the quarter. Thank you.

This concludes today's Parker Hannifin second-quarter 2005 earnings release conference call. You may now disconnect.