派克漢尼汾 (PH) 2006 Q2 法說會逐字稿

Good morning. My name is Holly and I will be your conference operator today. At this time, I would like to welcome everyone to the Parker-Hannifin Corporation second-quarter earnings release conference call. [ OPERATOR INSTRUCTIONS ] I will now turn the call over to Ms. Pamela Huggins. Pam, you may begin your conference.

Thanks, Holly. Good morning; this is Pam Huggins, speaking. I'd like to welcome you to Parker Hannifin's second quarter investor teleconference. Joining me today is Chairman and Chief Executive Officer Don Washkewicz and Executive Vice President and Chief Financial Officer Tim Pistell. For those of you that are online, you can follow along with the slides that have been presented. For those not online, the slides will be posted on the investor relations portion of the website. Our call will be in three parts today. First I'll provide an overview of the quarter including some of the key performance measures for the quarter and year-to-date and concluding with a revised outlook for the remainder of fiscal year 2006. That should take about 15 minutes. I'll then open up the call for a Q&A session. That will last about 45 minutes. As is customary, please limit your questions to one at a time in order to give everyone a chance to participate.

Backing up just a minute though, I need to say for those of you who haven't already done so, would you please read the forward-looking statements in its entirety. And, also, there's a slide presented on non-GAAP financial measures. That slide just indicates that where non-GAAP numbers have been used that we've taken an opportunity to reconcile them to the GAAP numbers. As you read in the press release this morning, Parker has again enjoyed another record quarter of sales and income from continuing operations. The results continue to be seen from the Wynn initiatives that we've been talking about for some time. The strong sales and income, coupled with the double-digit order growth we've seen recently, gives us confidence that this strength will continue for the remainder of the fiscal year. At this time, moving to the first slide with the financial numbers beginning with earnings and for those not online, please refer to the chart in the press release. Starting with the top row of the chart, we reported on a GAAP basis earnings in the quarter of $1.07. This versus $1.41 in the second quarter last year.

Looking at column two, you can see that the $1.41 from last year, however, includes $0.50 from discontinued operations. This was a divestiture of the Wynn specialty chemical business that we talked about last year at this time. In the current quarter this year, we also took a loss of $0.08 from the sale of our Thermoplastics division and an expense of $0.03 related to FAS 123R, as you well know equity based compensation or stock options. Removing this $0.08 from the sales of business and the $0.03 related to FAS 123R from this quarter earnings and removing the $0.50 from discontinued operations from last quarter earnings a year ago, we have earnings per diluted share from continuing operations of $1.18 this quarter. This compares, however, to $0.91 for the same quarter last year. This is a 30% improvement. Removing the $0.03 related to FAS 123R taken in the quarter from the $1.18, gives an adjusted number of $1.15, comparable to and above the analyst mean estimate of $1.13.

Moving to the next slide, slide two, this slide compares earnings from continuing operations for the second quarter and year-to-date versus the same period a year ago. While this can be seen from the previous slide, I think it's important to point out that earnings per share for the second quarter was $1.07 and year-to-date $2.27 versus $0.91 last year and on a year-to-date basis $1.96. That's a 16% improvement year-to-date and 18% for the quarter. The next slide, the strong earnings growth on a consolidated reporting basis in the quarter is the result of a 50 basis point improvement in the gross margin. This was led by a 16% increase in segment operating income in the North America Industrial segment. We also benefited from the lower tax rate. The tax rate moved from 28.9% to 26.5% in the quarter. Total shares outstanding also was a benefit. They were reduced as a result of the share repurchase program. Please note that without Thermoplastics' loss, the $0.08 that I talked about earlier which is included in Other expense for consolidated reporting purposes, Other expense was relatively flat period to period.

Earnings were partly offset, however, by higher selling, general and administrative expenses. However, as a percent to sales, the expenses remain flat with last year and on a segment reporting basis the expenses were actually down 7%. Also we had higher interest expense, albeit it minor, and higher taxes in spite of a reduction in the tax rate for the quarter. As I said earlier, the tax rate decreased from 28.9% to 26.5%. The next slide, moving to sales, sales for the quarter were up 13% from the same quarter a year ago, increasing to 2.2 billion from 1.9. Of this 13% sales growth, 8% came from acquisitions, 7% organically. However, this was offset by 2% from currency, mainly the Euro. The Wynn Strategy has set a goal for Parker to grow 5% from acquisitions, 5% organically. So of course we're happy to again report we are meeting our goals to grow this company year in and year out. Just as importantly, we experienced positive core sales growth in the quarter across all of our business segments and across all of our main geographic regions.

The next slide, our strong double-digit sales growth in the quarter is partly the result of continued industrial end market strength with our global network of distributors. And in end markets such as mobile, which, of course, includes agriculture, construction, heavy-duty trucks and then, of course, general industry was strong. The successful and fast integration of recent acquisitions, we completed six acquisitions in the quarter. Annual revenues totaled approximately 490 million. We also saw continued strength in the commercial aerospace business. And then I'll just move to segments here. Talking about segments starting with North America, Industrial segment operating income is 30% higher on a year-over-year basis. We moved margins from 12.2% to 14%, getting close to Parker's 15% goal. For the second quarter, core sales increased 5%, acquisitions added another 7%, foreign exchange contributed 1% resulting in a total sales growth of 13%.

Moving to the International Industrial segment, operating income is 10.5% higher than last year. However, operating margins decelerated from 10.6% to 10.1% in the quarter. But on a year-to-date basis margins are still ahead of last year. And this is due to mainly acquisitions made in the quarter. Core sales increased 7%, acquisitions added another 16%. However, we did have an offset as a result of foreign exchange, mainly the Euro, which cost 7% resulting in a total increase in sales of 16% for that segment. In the Aerospace segment operating income for the quarter is 4.5% lower on a 6% increase in sales. This reduction in operating income on a year-over-year basis is the result of a shift in business mix to commercial OEMs. As you know, they carry a lower margin and new product win development cost. The current strong margins in Aerospace are in line with the expectations previously articulated and in line with the annual guidance previously issued.

Core sales in that segment increased 6%. There were no acquisitions and foreign exchange didn't have an impact. Operating margins decreased from 15.2% to 13.7% in the quarter, but again on a year-to-date basis are at 14.7%, in line with our expectations. In the Climate and Industrial Control segment operating income is 11.3% higher in the quarter versus the same quarter a year ago. However, operating margins declined from 5 to 4.8%. The decline is the result of restructuring charges in that segment, we talked about this last quarter, and due to a plant consolidation and the move to a lower cost manufacturing region. Climate and Industrial Controls core sales increased 16%, acquisitions contributed 2% offset by 1% from foreign exchange resulting in a total increase for the quarter of 17%. Just to touch on year-to-date results for a moment. For the first six months of fiscal year 2006, sales were 4.3 billion. This is up 13% as compared to sales of 3.8 billion for the same period last year.

Cash flow from operations, very good, reaching a first half record, 430 million or 10.1% of sales, surpassing 354 million in the same period last year or 9.4% of sales. For the first six months of fiscal 2006, fully diluted earnings per share was $2.51 compared to $2.52 per share reported a year ago. Fully diluted earnings per share for the first six months of the current fiscal year include the loss of $0.08 from the divestiture of the Thermoplastic division, an expense of $0.13 related to FAS 123R and then $0.24 from discontinued operations. Adjusting for these earnings from continuing operations was $2.48 per diluted share. This compares to fully diluted earnings per share from continuing operations of $1.96 for the first six months of fiscal year 2005. The $1.96, however, is derived by beginning with a reported earnings per share figure of $2.52 and adjusting for a gain of $0.56 per share related to discontinued operations. The table in the press release bears this out and hopefully helps you in reconciling those numbers.

Moving to orders for a minute. Orders gained strength during the quarter across all segments. We're particularly pleased about our order growth. It provides further confirmation of the expected strength and sales as we move ahead to the third quarter. Orders are stated as a percentage increase over the prior year, as you know without acquisitions and currency. In North America order growth was 13% in December on top of 4% growth a year ago. Rest of world orders, the growth in December was 14% and that's on top of a strong 15% growth a year ago. In the Climate and Industrial Control segment, we continue to see orders of strength. That's largely as a result of the new seasonal energy efficiency ratings or what we call the SEER mandate. Orders grew 20% in this segment in December on top of 4% growth a year ago.

Aerospace continues to be strong on both the commercial OEM and MRO side. Orders in that segment were up 13%, which is on top of a strong 25% a year ago. And please remember that Aerospace, due to the volatility from month to month, is reported on a 12-month rolling average. Orders through Parker distribution channels continue to be strong. As you know, Parker serves some 1,200 markets which helps mitigate any volatility in specific sectors. Now I'll just touch on the balance sheet for a moment. Our balance sheet remains strong. We ended the quarter with 313 million of cash on hand. Working capital was a source of cash for the quarter. Inventory in terms of DSI is down to 71 from 76 from the same quarter a year ago. Accounts receivable in terms of DSO is up two days. This is due to acquisitions and the natural cycle of our business. It tends to peak for the year in the second quarter and then decline during the last two quarters of the year.

Parker continues to have strong operating cash flow generating 430 million, up from 354 million a year ago. This is 10.1% of sales. This cash flow, 430 million was used for capital expenditures, 106 million in the quarter representing 2.9% of sales, and then 818 million for acquisitions, thereby increasing debt 435 million in the quarter. However, our debt to cap ratio still remains low at 31%. On a net basis actually 26.6%. At this time I want to move to the guidance for the year. Our strong orders indicate favorable market demand and we expect double-digit sales growth for the year. We further expect to improve margins and deliver record earnings and cash flow performance for the year. As a result, we are raising the lower end of the guidance. The guidance is moving from $4.85 to $5.30 per diluted share from continuing operations to $5.05 to $5.30 per diluted share from continuing operations. Please remember that the guidance issued last quarter didn't include or anticipate the $0.08 loss related to the divestiture of the Thermoplastics division.

As we advised last quarter, this guidance is after the expense related to equity based compensation. The guidance today at $5.05 to $5.30 excludes the loss on the Thermoplastics division, as I just said, and includes expense associated with equity based compensation. I just want to make sure that everybody understands that. Equity based compensation expense so far for the year is $0.13 and we continue to project it to be approximately $0.20 for the year. Our specific sales guidance for 2006 on a segment by segment basis is as follows and represents percentage increase over fiscal year 2005 sales. North America Industrial sales are projected to increase 12.4 to 12.8% for the year. Rest of world Industrial sales are projected to increase 16.6 to 18%. Aerospace sales will increase 7% to 7.8% and Climate and Industrial Control sales will increase 17% to 18.5%.

On the margin line, the guidance here is stated as a percent of sales for fiscal year 2006 and I'll do it on a segment by segment basis as well. North America Industrial margins are projected to be in the range of 14.2 to 14.6%. Rest of world Industrial margins are projected to be in the range of 11.2 to 11.8%. Aerospace margins 14.3 to 14.7%. And then Climate Industrial Control margins 8.9 to 9.1%. Going to below the line items, as we call them, corporate administrative expenses will increase in the range of 11.5 to 12.5% versus fiscal year 2005. Interest expense coincidentally will be up 11.6% to 12.5% versus fiscal year 2005. Other expense will be up 25 to 30% over last year due to equity based compensation expenses. The tax rate for fiscal year 2006 is projected to be 28.5%, down from 30% projected at the beginning of the year and down from the 29% guidance given at the first quarter earnings release call.

So, just to summarize real briefly, I ran over just a little bit. Sales were up in the quarter of 13%. Earnings per share from continuing operations as reported of $1.07 in the second quarter was 18% higher than earnings per share from continuing operations for the same year, same quarter a year ago of $0.91. On an adjusted basis earnings from continuing operations was 30% higher. Cash flow continues to be excellent providing the capability to grow through acquisitions and organically. And the focus on the Wynn Strategy continues. Orders remain solid and the integration on the recent acquisition is successfully moving along. So, before we move to open the call for questions, let me say that it's clear from our performance that Parker's executing on our Wynn Strategy with great results. More importantly, we believe that the strategy to strengthen our company so that we can perform well in good economic times and bad has also begun to have a positive impact on the company and that bodes well for the long term. So, at this time, Holly, could you please open the call up to questions.

Yes. If you do have a question at this time, please press star then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question is from the line of Alex Blanton.

Good morning. I'm with Ingalls and Snyder. Pam, your CapEx is 2.9% of sales in the quarter. And it typically has been in the past 5% of sales and you explained why it's running less now than in the past. Do you expect it to be around 3% for the year? And why is it a couple of percentage points below? It's contributing to your cash flow, obviously, since cash flow is still running about 10% of sales.

Alex, Tim Pistell. Your memory is accurate, that typically at this time of the recovery in an expansion our CapEx would be running 4.5 to 5% of sales. And we also continue to feel that the new go-forward rate of expenditure should be in the 3 to 3.5% range. We are a little bit below that. We have come up some. We are a little bit below that. I would say the big difference, Alex, right now is that we're not looking for a lot of land and buildings that we typically would be going for at this point in time. We are buying equipment into the plants that we need. We are not really seeking out a lot of new land and building. We have freed up enough space in the plants that we have that it works well. So I think that again we would advise all of you in your modeling going forward to use something in the 3 and the 3.5 and we probably could well finish the year right around that 3 mark this year.

Tim, the focus, really, though is not on what your cash flow is going to be per se, but on the reason for what has happened. Isn't it due to the lean strategy specifically that you have to spend less on CapEx than in the past so you have more to spend on dividends and acquisitions and so on?

Absolutely. Underlying the whole philosophy of what we're trying to implement here, which is -- and was sustained -- really changing our behavior on a sustained basis and we felt very, very firmly that if we implemented lean enterprise we would be able to operate the plants in a different fashion and you're absolutely right. The adoption of lean is what has helped us to free up the space in the plants and amazingly so. And also the way we approach tooling the plants is very different than we were done before. We don't build huge mammoth transfer lines and huge departments doing just one machining function. We now have small cells, we're going to one piece flow. It's a completely different configuration of the plants. And the good news is that the capital that's required to do that is far less expensive. So, yes, what's enabling us to do it is the adoption of the lean enterprise.

Thank you.

Your next question is from the line of Ann Duignan.

Hi, good morning. It's Ann Duignan of Bear Stearns. How are you guys doing?

Hi, Ann.

I don't know if they ever get your name right.

I got a couple of just quick cleanup questions first. You have kept your Aerospace margins for a full year at the same rate as they were at the end of the first quarter, even though Q2 was a little lighter than expected. Does this mean -- or should we interpret this as an expectation on your part that there will be another mixed shift going into the back half of the year or are you expecting that your engineering spend is going to slow down? Could you just give us some color on what you expect is going happen in the back half of the year there in Aerospace?

Right, Ann. I think that that's a good question. And we really haven't changed our position on Aerospace. I think that moving forward -- as you know, the commercial OEM side of the business is the part of the business that has really grown this year. And that is the -- obviously the lower margin side of the business. I do expect on the military side, believe it or not, on the MRO side, there will be an increase in business in the third quarter. It's just the way things are falling out. There's nothing unusual going on there. It's just the way it's going to fall out. We haven't really changed our stance on Aerospace from the beginning of the year. They came out a little stronger because there was a -- proportionately there was more MRO in that first quarter. But going out, we're keeping our stance pretty much the same. I think that the OEM business will continue to be the strong side of the business. But there will be a little bit MRO business in the third quarter that is a little bit different.

Okay. So the military business that you expect to pick up in Q3 is military after market?

That's right. Thank you for that clarification, too.

Okay, good. Thank you. A follow-up on your acquisitions. Does the sum of all your recent acquisitions change any of your traditional seasonality which tended to be a little bit stronger in the back half of the year than the front? And/or does it change your mix in terms of your products going to the different channels, i.e. does it change your 50% of your business's distribution, 50% OEM? Could you just give us some color on, should we be looking at our models any differently going forward as a result of all the acquisitions you've done?

Ann, this is Tim again. At this stage I wouldn't look at your models -- I wouldn't make big changes in your models right now. But part of the strategy here that we've tried to articulate to everyone is that we are trying to invest in businesses that have slightly different secular stories to them, if you will, and have different life cycles to them, if you were, business cycles to them. Yes, I think that they will over time. We're very much trusting that they will help mute the cyclicality of our old core motion businesses, which are great, track pretty much together. But the filtration tracks differently. The refrigeration tracks differently. And over time I think we will see that begin to come through. But I think we need to let that play out and see how that impacts us. But that is why we are interested in those fields and why we will continue to look for opportunity in those fields.

And is that the rationale behind setting the 5% organic growth going forward then? Or is the 5% organic growth based on GDP X and we're going to outperform GDP by Y?

Ann, we've had the -- we've had a 10% growth going now for probably 15 years. And basically, if you look at it historically, we've been anywhere from 4 to 6% internal growth over that time frame. So all the goal was was a continuation of what we thought we could do based on the generation of the free cash flow that we had been generating in the past. As far as our acquisition growth and the balance had to come from internal growth and supported by a lot of the other activities that we have outlined on the Wynn Strategy and customer service and so forth and system solutions selling, what have you. So we just maintain that. Now, we fully expect that in a good year where we're generating a lot of cash, we're going to grow faster. And that's what we're doing now. We're pulling up the average of the last five years. Of course, we went through the recession and we grew a couple percent. We did -- it was positive, but it wasn't obviously 10. So what we're doing now is we're really pulling up that average so that we can get back to a five-year average of 20 -- or of 10%, similar to what our 20-year average now is running close to 10% growth. So that's really how the target comes about. And we feel pretty confident we can do the 5 and have done the 5 for quite a number of years. Hopefully, as a result of our winnovation efforts go on here, which we will showcase more for you as time goes on, that's going to drive internal growth as well and, hopefully, to higher levels in the future.

Okay, I'll get back in line. I don't want to monopolize the time. Thanks.

Your next question is from the line of Andrew Casey.

Good morning.

Hi, Andy.

If I could dig into the rest of world margins a little bit more. I know, Pam, you indicated that most of that was due to acquisitions. Was there any realignment charge taken in the quarter, qualitative is fine.

Andy, this is Tim. Yes, there's two things going on in International that you people need to be aware of. One is there was a nominal amount of restructuring. I think you still, as much as we try not to talk about it, it still comes -- it comes through the Q here. But it's a nominal amount, call it $1 million or so, I think that will come through on the Q. More significantly to the -- I'm sorry, excuse me. I think in rest of world it was more like $2 million. I think we had 1 million in North America and a couple of million in rest of world in terms of restructuring. But, more significantly than that is the fact that we have a mix change in International, where as Europe is improving for us and it's coming along nicely. Not dramatically improved but it is improved. And that's helping. The problem we have is Latin America, which was doing very well and when it does well, it earns high margins Even though it was in the doldrums due to the Brazil situation in ag. The good news there is we see the beginning of a turn, we think, down in South America on that ag. And so that will be nice if that occurs. We haven't seen a lot, but it's just the beginnings of something. But what you have there more than anything is a mix change. A little bit of restructuring as well.

Thanks, Tim. And then if you said it, I missed it. Could you remind me why corporate and general was a little bit down year-over-year given the annual guidance being up a little bit?

There's just -- again there's some anomalies that kind of run through there where we're truing up incentive pays. And we also have some legal accruals that come through there. So it's generally a question of tweaking the estimates on the pending legal cases that we carry, corporate work or tweaking the incentive pay. So I can't give you more specific than that.

Okay. Thank you very much.

Right.

Your next question is from the line of Gary McManus.

Yes, JP Morgan. My question, first question is related to your revenue guidance and Industrial rest of world. If I look at the midpoint it's like 17.3% growth and before you had midpoint of 16% growth. That 1.3 percentage point difference is about $30 million of revenues. But if I remember correctly, your prior guidance did not include Domnick Hunter. I assume today's guidance does include it. Owning Domnick Hunter for seven months or so, given that most of the sales are International, should give you, maybe, something in the order of $120 million revenue growth. It appears like you're lowering your revenue guidance for Industrial rest of world if I exclude the impact of Domnick Hunter. Can you square all that up for me?

The one thing, Gary -- I guess I didn't see it that way. Did you take into account the FX? Because, really, what's happened to us in this year, we had -- we've had a big swing in foreign currency from the first quarter to the second quarter. In the first quarter foreign currency was actually favorable for us. And then the second quarter it turned unfavorable by a lot. I think year-to-date we're at like 30 million for the International side of it. So it was like 10 million favorable first quarter and then 45 -- that's total I think.

Excuse me. It was 17 favorable the first quarter in total and 47 unfavorable, so now we're at a 30 unfavorable year-to-date.

Right.

So you would say the implied lowering of revenue guidance in Industrial rest of world is primarily because of adverse currency? Nothing else related to end market conditions?

That's exactly right. That's exactly right. I mean, we added in the acquisitions and we also took care of the currency.

Okay. Other question I have is on the loss of the sale of the Thermoplastics. Can you give both the pretax and after tax dollar amounts?

Yes. We don't like to get into a lot of detail minutiae on this, as you know. The business was around 25 million a year in sales and it was making money, a little bit of money. It was 100% devoted to automotive and just did not fit with us strategically. I mean, again, it wasn't -- it was just something that we picked up along with the Wynn's acquisition. So this is one of the small ones that was hanging out there. So we have -- looking for the opportunity to find a buyer, which we did. And I would just say that the write-off that we suffered, interestingly, all pertains to goodwill. Way back when when we purchased Wynn and there was goodwill involved, we had to allocate that around at different business units and clearly we got a little overzealous in allocating goodwill to this business. So we pretty much recuperated everything on the hard assets and the write-off was writing off the goodwill. So I think it was the right thing for us to find it a new home and it has ended up with other people who are in the business. It was the right thing to do all the way around.

I'm sorry. I just wanted to get the financial impact. If it was $0.08 a share loss, if I assume 120 million shares, it's like 9.5 million. Do I tax effect it at the 26 -- ?

Gary, I can tell you that there's about 7.5 million that's nondeductible.

Right. That's the goodwill. The goodwill is nondeductible.

There's 7.5 million that's nondeductible.

Okay. I'm just wondering how much that influenced your overall tax rate in the quarter then? Right?

It did.

Okay, great. Thanks.

Yes, you're exactly right.

Your next question is from the line of Andrew Kaplowitz.

Good morning. Could you talk about the CIC unit in a little bit more -- you had mentioned restructuring before for 2Q. Are we done with restructuring now in auto and what should CIC look like on a go-forward basis in auto.

This is Tim speaking. Most of the hits related to the restructuring were taken in this half. There will be additional, a little bit additional expense in the first couple of months of this year. Then what we'll see is the benefits kick in. We're hoping that by the end of the year we can earn back, if you will, by having closed facilities and relocating that production into lower cost facilities we'll earn back a portion of these charges we are taking right now. So, most of it's been recorded, a little bit more in January and February then we'll start to see the benefits.

Tim, was the impact a little worse than you expected in 2Q? I mean, the margins that you had seemed a little bit lower than we thought. Was that because of restructuring or more restructuring than you expected to do in the quarter?

No. I think the restructuring pretty much is going as we planned. I think on top of that, of course, is all of the, unfortunately, the bad news coming out of the auto industry and the Big Three and in their first tier suppliers. And we have been adversely impacted by some of those situations, such as Adelphi.

Okay. I understand. Just shifting gears for one second in Aerospace. 6% growth is good, but your orders are tracking a lot higher than that. I know that Pam mentioned that military MRO would pick up in 3Q. It's a lumpy business, so are we going to see pickups in general growth rates going forward?

Well, we think that the Aerospace is going to remain strong on the commercial side for the foreseeable future. I think the military side is pretty stable. I don't think we're going to see any major changes one way or the other on the military side. And with the passenger travel being at pretty nice levels, if anything, we'll probably see a little bit of pickup in the MRO or the after market side of the commercial portion of the business. So, the outlook is good. I think it's positive. I think we're planning to see continued strength in that -- in the overall segment of the business. I hope that answers your question. By the way, that was Don answering that.

And Andy, this is Pam. Aerospace is running at about 5.5%. We really have them forecasted from 7 to 7.8. So we really do have them going up, moving their numbers up in the second half and on a yearly basis.

Okay.

At the risk of piling on here, I wanted to mention that the -- I must say our Aerospace team are doing a very, very nice job also of penetrating the Airbus. I go back a few years, we had very little with those people except on the engines and they have worked extremely hard to get on these new aircraft. They have won some significant building materials. And that bodes well for them as well.

Tim, what's the split of Boeing Airbus? Could you tell us that?

In terms of for us?

Yes.

Unfortunately, no, I honestly can't give you that. I would have told you that ten years ago it was hugely weighted towards Boeing. Maybe Pam has some data on that. I don't know.

No. What I can tell you though, is I know that Boeing, they've moved from 17 to 28 planes a month and Airbus is 17 to 32. So when Aerospace talks about the business, that's the way they talk about it. So Airbus actually is ahead of Boeing a little bit in terms of the business.

Their question is I think more what percentage of our total commercial business is Boeing versus Airbus? 80/20, 70/30?

That’s right.

I know we're much heavier on Boeing. I'm just talking about in terms of close.

Okay. Well, thanks very much.

Right.

Your next question is from the line of Mark Koznarek.

Hi, good morning. It's FTN Midwest. Just want to try and square some numbers up here because you raised your guidance, your earnings guidance midpoint to midpoint by $0.10 a share. Yet as you look at the pieces, when you look at how you detailed the changes in the outlook, it looks like your operating income is up by nearly $0.20 and then you're getting an extra $0.05 or even a touch more from a better tax rate and, of course, you're absorbing more interest expense and that's around $0.10. But it seems like your outlook could be $0.05 or $0.10 higher at the midpoint. I'm just wondering if you can help me square that.

Well, maybe I just make a comment. I think -- Pam, I'll let her get into the actual numbers side. But I think what we see here that we can have visibility of is really six weeks of orders. I think you need to keep that in mind. So our crystal ball is really a six-week crystal ball and -- which it looks very good, by the way right now. I think that's all baked into the forecast as well.

So there's a certain amount of conservatism in there just when you add everything up, you throw in some windage on the conservative side?

I would not use that word myself, only because I know the reaction that everybody will take as the result of me saying that. So I would just say that I think our forecast (indiscernible) is prudent and it's realistic given what we can see at this point in time.

Okay. And just one detail here with regard to the foreign exchange expectation. For the full year, what are you guys thinking about now in terms of total foreign exchange impact versus where were we 90 days ago?

Mark, we don't really try and project what foreign currency is going to do. What we do basically is assume that the rate that exists today is the rate that's going to exist for the remaining part of the year. We don't really try to guess where those rates are going to go. Whatever it is is the way that we project going forward.

So what that implies is since we had a 47 million negative impact in the quarter, that degree of impact may persist, not necessarily the dollar amount, but the exchange rate relationship that led to that you're forecasting stays stable?

That's right. That's right.

Sounds like the second half there actually is a pretty significant negative revision to your outlook because of foreign exchange?

Correct.

That's right.

Okay. Got it. Thank you.

Your next question is from the line of Robert LaGaipa.

Hi, good morning. Just had questions. One, not to belabor the Aerospace sales figures, but I just want to dig down a little bit deeper in terms of the Aerospace sales in the quarter. Now, I remember last quarter you had mentioned that the after market mix was a bit better. That had led to the margins being significantly better. Here in the second quarter, the fiscal second quarter, obviously the margins decline. I imagine that the after market business on the OEM side wasn't as high but the sales were fairly flat. Can you just maybe give us a sense for, sequentially, given that sales were roughly flat, what changes that occurred? Was it just a function of the OEM business becoming larger and the after market business falling by a similar amount? Or what exactly happened sequentially?

Yes, I think -- this is Tim. I think we did try to explain that last quarter because they did start unusually well. They had -- and they enjoyed an unusually strong mix of after market business and therefore performed very well. We were trying to warn people, this is not -- we don't think it's sustainable. What we think is going to happen is what we told you was going to happen at the beginning of the year and that we'll settle back down and we'll have a higher content of the OE and less of the after market. And I think that is, in fact, what happened in this quarter. The other thing that goes along with that strength in the OE, and is absolutely occurring and running through their numbers right now, is something called the NRE, the nonrecurring engineering. When you win on program, you must expend a lot of dollars on engineering. No guarantees. You got to spend it up front. So, along with bookings are lower, lower margin OE business, you are incurring some significant engineering costs to get those programs up and started. So, that is what's occurring. I'd just say the first quarter was more the anomaly with a higher degree of after market than we had anticipated.

But with the after market, I guess, that would imply that if the OE picked back up in the December quarter, that the after market declined, one, correct me if I'm wrong, if it didn't decline, then I guess my question is, what gives you the confidence on a go-forward basis that that OE after market business starts to pick back up again? The context of this question is just in terms of the margin expectations, the sales expectations. I just want to get a better sense for that moving forward.

Again, when we're booking orders on the OE side, the lead times on that are 12 to 18 months to 24 months. These are very, very long lead time items in terms of when we will be getting those things back out. Again, the confidence here, I guess, is that we have that. I mean, that's highly predictable, both military and commercial. The wildcard in Aerospace really is this after market. Are we going to continue to be sustained either on the commercial side or on the military defense side, or is something going to happen there? We're feeling pretty okay right now. Two reasons. One is we think there's a sustained effort that's still required on the military defense side, for right now anyways. And so we're not looking for a big downturn on that. And on the commercial side, a lot of people are flying. The planes are full. Airlines marginally are doing better and so we think that the after market will continue at a -- not looking for a big pickup, but we think it will continue at a solid level.

Terrific. The other question, if I could, is just on the acquisition side. Year-to-date what's your acquired revenues? What's the amount that was spent on acquisitions? What impact -- I know you mentioned a couple of million dollars on the International side to the margin of the operating income. What was the impact in the quarter? Do you have any idea of what the impact you're expecting to be in the third, fourth quarter?

Let me just try and address that a little bit. In terms of acquisitions, annualized revenue this year is about 702 million, okay?

Yes.

Obviously, with a larger portion of that in International rest of world and North America due to the Domnick Hunter, which is the biggest portion of that. What we have in our guidance right now is somewhere less than 500 million. It's less than that. And what's the other part of your question? In terms of the impact of the – (multiple speakers)?

Yes, in terms of the impact. I know you had mentioned in the quarter it's a coupld of million dollars in terms of the restructuring. I just wanted to get a better sense for on a go-forward basis. Are you expecting that to escalate and, if so, by how much?

I think there's a miscommunication or misunderstanding there.

Okay.

The couple of million dollars on the restructuring did not pertain to the acquisitions. That was going on within the base businesses.

Okay.

Okay? The acquisitions themselves, we're extremely pleased. We paid a premium for some of these properties because we thought they were the gems available, if you will, and low and behold it's turning out to be so. It appears and again, as Pam indicated, we bought a little over $700 million worth of revenue. We've only really been able to book around 300 million of that 700 just because of when we booked them, okay, in the year. So we have a lot more to come here is when we have them for a full year. To date they are delivering margins that are very close to 10%. And that is after deduction of amortization of the goodwill, the intangibles, which we think is going to run in the range of 4 or 5%. So I just want to indicate that these brand new acquisitions are coming in here and making the top-line and are -- as I say, you guys can do the math. As I say, the margins are not quite at 10 but darn close. And as I say, that amortization is about 4 to 5%. So they're doing well for us.

Bob, as far as the restructuring goes, what I have been saying is that we have said that restructuring would be $0.09 to $0.10 a year. If we would move outside of that I would make sure that I would let you know.

Okay.

Okay?

That's terrific. Related to this acquisitions now, the fact that you have $500 million plus of new payable current debt, is there plans to extend that out at some point?

I'm sorry --

Not right now. No. We feel that the cash is sufficient to be able to pay. We don't have any plans to do anything right now. As you know, we just rolled our Euro bonds.

Yes.

We had about 300 million and we moved it up to 400 million. That's what you're seeing in the cash flow statement. But not at this time. We think that the cash generation is good enough to pay for it using just our commercial paper.

Terrific. Thank you very much.

Thank you.

Your next question is from the line of Jamie Cook.

Hi, good morning.

Hi, Jamie.

My first question -- sorry, I just want to follow back, actually, on Commercial and Industrial Control. It sounds like the quarter in that segment is running along as you plan, yet the margin guidance seems a little bit lower. So I think I'm just missing something there, if you could explain that to me first.

Well, Jamie, it's Pam. One of the things that's happening -- we talked about the restructuring and the Climate and Industrial Control business that was taking place due to the plant consolidation and move to a low-cost region. That has taken place. What's actually happening is the restructuring is moving just a little bit slower than what's anticipated. So you're seeing the cost in this first half and the savings is coming in the second half. So it's just moving out a little bit.

Okay. That's fair.

It's just moving out a little bit. It's not that it's not going to be there. It's taking a little longer than we anticipated.

And then second, could you just comment a little more, you mentioned you're seeing some strength in Europe. I guess, could you just give a little more color by country or in what end market you're seeing the strength?

Yes, I can talk about that a little bit. One of the things I think is happening in Europe, and I know -- we've been talking a long time about our systems selling and what we're doing throughout the company. And really, when I go to the operations management meetings within Parker and I listen to everybody make their presentations, one of the things we're really benefiting from is our systems selling, just a result of the restructuring that we've done there. We've put trading subs into the Big Three and we've combined the sales forces and everybody's heard about the initiatives. But those are really truly paying off for us. And so we really are being able to come to the customer with one face. As a result of this, we're getting business that we haven't had before. But when you look in terms of -- agriculture is very good in Europe, even though it did soften in North America for a little bit. So agriculture is good, construction's good. You look at the countries, Germany, which is the biggest country for us, is doing very well.

Okay. And then just last quickly, on Domnick Hunter you guys gave sort of, or you talked about preliminary numbers for the full year during your Domnick Hunter conference call. You didn't mention it in this call. Should I assume that's about the same?

Yes, that's accurate.

Okay, great. Thanks.

Jamie,maybe -- .

Actually there's -- go ahead.

Sorry. Is it better?

They're doing well. They're on track. Let's put it that way.

Okay.

Jamie, this is Don. I just going to be able to give you a little bit more highlights on some of the European countries. I have a whole list of about 25 here that we track. And, like Pam said, Germany is double-digit order growth, so that's real positive. Other big ones would be the UK is up double-digits, Sweden's up double-digits. That's another good size one. The Netherlands, actually pretty flat in the Netherlands and also France is pretty flat, as far as orders. So some of those would be the bigger countries that we would service. Denmark being positive as well.

Okay, great. Thanks very much, guys.

Sure.

Your next question is from the line of Jeff Hammond.

Hi. North American Industrial margins look like you raised your guidance by about 60 basis points. Tim, it sounds like from your comments that the acquisitions would at least be dilutive to Industrial, North American Industrial margins. Can you give us a sense of what's driving that? Is it just -- is it mix? Is it execution? Or are some of the North American acquired businesses higher margin?

No. It's just good execution, I will tell you. It is wonderful to see. You've met with some of the group guys, I know, Jeff. Some of the larger groups, the connectors, the hydraulics, no question that is -- all the Wynn initiatives we've talked about are coming through. I'll tell you another group that is really coming along well, that we feel very good about because it's shown us -- we tried to implement sort of a new model in our instrumentation group, where they really suffered from the ups and downs of the semi-con. We had one business unit that historically when semi-con would collapse, they would have a hard time staying in the black. They would often lapse into the red. We just lived through a downturn and we were solidly in the black all the way through. Now things are picking back up. That's showing -- that's very nice for us. So, it's a combination of that and the restructuring, as I mentioned. I had my numbers a little wrong earlier. There's very little restructuring going on right now in North America. We got CIC doing the most and then Internationals, a couple of situations. North America Industrial is very, very little. I think they did a lot more last year. So it's that combination. But, if I could sum it up, I would say it is the Wynn initiatives that are just paying the dividends.

Okay. Then on CIC can you give us an update on Sporlan, how that's performing, relative to expectations? And then is Kenmore in the new guidance, because you raised your revenue guidance? Or is that benefit from 13c. And I guess if Kenmore is in there, what impact would that have on margin guidance.

Sporlan is in their numbers. It is performing exactly to plan. It's been wonderful. That's great. Kenmore is brand new and not only are they brand new, but before we bought them, they had plans to do a major relocation within their plants in the UK and in the throes of doing that. But early days. We're still just really thrashing through that. But they're operating to expectations and we're very, very excited about that addition because they bring us a plant in Turkey, a large plant in Turkey, which is where the white goods industry is moving in Europe. That's exciting. And they have a wonderful plant in China doing over $20 million a year in white goods, about half of it stays in China, half is export. So we got some really, really nice capabilities with Kenmore. But it's very, very early days on that. They're not adding a lot right now because we're in the middle of this fast integration.

But Kenmore has closed and incorporated into the guidance?

Yes, it is.

Okay.

We're not looking for a lot out of them bottom-line. Sporlan, we've owned them for a year. We're absolutely expecting very nice returns out of them on the bottom-line now. They've been on board a year. Kenmore, as we've said before, the first couple of quarters we'll spend a lot of money to get the integration done. We don't expect a lot on the bottom-line. Add to the revenue, not a lot on the bottom-line.

Okay, great. Thanks.

Your next question is from the line of Chris Kotowicz.

Good morning. I wanted to ask a question about FX. We talked about that on Industrial rest of world on the top-line. Did that have a meaningful impact on the profitability as well?

What it means to us, as we've told people for years, we tend to try to naturally hedge on FX. In other words, most of what we sell in a region we make in the region. So, when you see the revenues, let's say, being down whatever the number --

50 million or whatever.

50 million. Then the cost should be down likewise and it's only on the margin that we lose. But yes, there is an impact. If it's 50 million, we probably are suffering 4 or 5 million at the bottom, at the operating margin level.

Okay. Maybe tying into a prior question on the margins in North America versus Internationally around that 10% number that you threw out after intangibles. Is it safe to say that it's more like a 12 number in North America and an 8 number in rest of the world? I mean, are those reasonable approximations for us to think about going forward on the acquisitions?

We really don't disclose those numbers, Chris.

Okay. Final one then. Tax rate going forward, is it 28.5%? Is that something we should model in going beyond ‘06?

For now I'd say -- for now I'd say yes.

Okay.

We only get there by doing some -- we have constantly be working some different tax plans, but our VP of taxation knows that we don't ever like to see the tax rate go up.

Fair enough. All right. Thanks.

Your next question is from the line of Martin Sankey.

Hi. I have a very high class question here.

Who's on the line, please? Can you -- ?

This is Martin Sankey from Neuberger Berman.

Hi, Martin.

Hi. Okay. I have a high class question today. You have spent quite a bit of money on acquisitions so far this year. One, you're still somewhat below your targeted leverage level. Is the pipeline still full or could we see possibly the initiation of a share buyback to get your leverage up to the targeted level?

Martin, Don Washkewicz speaking. Just a couple comments. First of all, we are always looking at a lot of opportunities. And I think nothing really has changed this quarter with respect to what we're looking at. There's still plenty to look at and we're being prudent as to how we go through the evaluations, of course. Just kind of a review on what our cash policy is as far as how we're using cash. The first priority has always been and has been to pay dividends and increase the dividends year to year. I think you've seen the trend there for 50 years that we have done that and we'll continue to do that. The next thing that we set as a priority in this order would be our 10% growth target, okay. And, of course, we've exceeded that. Like I said, in the more recent time, as we're going through right now, we would want to see a higher than 10% growth because, frankly, in the weak period, which were the recession years, we had less than 10. So we're doing that. We're basically growing faster now than our 10% target. But that's by design. What we want to do is to continue that trend. As long as there's good properties to look at we're going to continue to grow the business both internally and externally through acquisition. As far as what's left then, certainly we review that. Our stock buyback, we do purchase shares back on a regular basis. Our goal is to really, at the minimum, to cover our dilution as a result of stock option exercises and possibly do more than that. We'll have another meeting coming up here shortly with our committee and we'll be reviewing what's on the table as far as acquisition opportunities and then what , if we want to do more, what we want to do as far as share repurchase and that all will be discussed here very shortly. So I don't have anything definitive to tell you now, but it's always one of the things we do review.

Okay. Thank you.

Can we take one more question at this time and then open it up. I think Don has a few brief comments to make.

Your final question is from the line of Robert McCarthy.

Good morning.

Can you hear me?

I can. Good morning.

I just had a couple quick follow-ups. Pam, during your prepared remarks on one of your slides titled Earnings Impact, one of the items listed was inventory changes. I don't recall hearing you say anything in your remarks about how inventory changes might have affected profitability in the quarter.

Right. Of course we increased inventory with the acquisitions. You take on a lot of inventory with acquisitions. When you look at the DSI, actually compared to last year it was down five days. Now it is up versus the beginning of the year but that's not unusual for Parker. If you look at the natural cycle of the business, you can see that we will typically build inventory halfway through the year and then it comes down the third and fourth quarter by a lot. So, yeah, inventory we did build as a result of acquisitions. Without acquisitions it's actually down, DSI is down five days over last year. So overall, I think in spite of the acquisitions, very good performance.

Okay. The charge on the Thermoplastics, I'm going to take another run at Gary's question. What was the pretax dollar amount of the write-down?

Well, you can take, again, there was no -- as I mentioned, most of that $0.08 was due to the goodwill, there was no tax.

I can work out a calculation, Tim. I just thought you might be able to provide us with the actual number.

11 million.

11 million. Thank you.

7.5 million was nondeductible.

I'm sorry?

7.5 million was nondeductible.

Nondeductible, right. And then my last question, maybe Tim for you, a little bigger picture. As I think about Aerospace prospects beyond the second half of this year which, of course, is detailed in your forecast.

Right.

If I assume a world where you don't have any -- you don't really have any growth in your defense business and you have very modest growth in commercial after market and so consequently commercial original equipment business accounts for most of their growth, what do you think is a reasonable estimate for incremental operating margin for that business? Are we talking something like a 20% level? Or lower?

I wouldn't dare give that to you without working with the Aerospace people. Why don't you calendar that for about the first of June, because we'll be going through their books for next year and I think some of those circumstances will be applicable to their forecast for next year. Maybe we can cover it then.

Okay. I'm happy to do that. Last one. I was also struck by -- you had a question earlier about Aerospace order growth rates and how revenue growth has been developing. I want to check something that I'm not sure I know. When you're adding up Aerospace orders in a given month, what goes into that bucket? Is it only orders shippable in the next, I don't know, six months, nine months, 12 months, 18 months or is it just everything that they book or what?

Well, again, it has to -- whenever we get orders, again, if we have firm releases, and that's the key, if there is a firm release date, then we enter it into the backlog. Now that customer could be asking for the part tomorrow or they could be asking for it in three months or they could be asking for it in 18 months. But if it's a firm order with a firm release date, then we put it in. We're very cautious on people who send us rolling requirements, because some people will give you three months and then they'll give you firm and then four, five months material. And so we're very cautious about loading more than the three months. We'll ship a month, add a month. That tends to happen more, let's say, with the auto and the construction and the ag people.

Okay.

Aerospace is very different.

Wouldn't it be logical for me to assume that within the mix of that business, you're more likely to get extended releases like that --

Yes.

-- on original equipment business.

Absolutely.

Okay. All right. Thanks a lot.

Okay. Thank you.

Okay. At this time, Don has a few comments to make and then we'll wrap up the call. Thank you.

Just a couple recap points, I guess. I'd like to first of all, of course, say that, needless to say that we had a great quarter and a great half. We're very excited about our performance at the company. And I think the point that I would like to make also is the fact that I think the results really do go a long way to disspell the notion that Parker is an early or a mid or a late cycle company. I think we're showing that we are performing pretty much across the entire cycle. So I think that's a highlight that I'd like to point out. The other thing, of course, is with the good growth rates that we're showing right now, one thing that I don't want anybody to miss is the tremendous underlying organic growth of the company, which was last year was just under 9% organic and 7% for this last quarter. So tremendous, we think, organic growth and we're hoping that that's showing up in the models as well. I think when we look at the organic growth, that we're looking at numbers. I just saw the other day in the journal where they said last quarter the GDP was like 3%. So we're outgrowing GDP by a multiple of 2 X times organically. We think that's very good. On the revenue side, course the revenue side is helping us generate EPS growth. EPS growth is greater than 20% now, excluding our option expensing and we're pretty excited about that. Likewise, on the cash flow side, we're very excited about where we are relative to our peer group. Last year I think we finished around 10.5% or 10.6%. And we're up now at about 10.1%. We were recognized in Barrons for our cash generation being in the top 50 that was selected for that list. I don't know if everyone picked up on that. But that was a very nice report on our cash generation capabilities. So I think all the numbers really just support the fact that we are executing on what we started five years ago now. It's been a five-year program which we call the Win Strategy. It's certainly generating wonderful results for the company. Just a recap a little bit on the order trend. We were very pleased with what we see there. I think just running through the world again. North America's strong, Asia's strong, Europe is good and most of the countries. Latin America, interesting, is showing some life again. We had been talking about Latin America going down down down. We're starting to see a little bit of life showing up there in Latin America. Aerospace is strong, especially on the commercial OEM. That's going well for us. In our largest market segment, and I tried to point this out the last time we had a teleconference, is really the MRO segment of our business, which is the largest market segment. It 40% of Parker. That's growing and doing very well. And then I think we highlighted earlier for you the instrumentation part of our business, which is serving the semi-con and the process, which had been trending down and had been really a negative from a growth standpoint, not necessarily from a bottom-line impact because we remained profitable on that unlike what we had done in prior cycles, as a result of some of this restructuring activities we took on here to get that business restructured properly. We think it's bottom and it's starting to recover now. At least the early signs here are that we're seeing a little bit more life in the semi conductor and process side of the business. We did a survey recently of our North America mobile OEMs. For the foreseeable future, the response as to the activity in that segment of our business looks favorable as well. So I think when we summarize all of that we expect another record year at the company. Barring any unforeseen circumstances out there, we think it's sizing up to be another record year and we're pretty excited about that. I just want to thank everyone on this call for attending today. Thank you for your continued interest in Parker and our progress. Did you need to say something? Okay. Thank you.

Thank you.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.