派克漢尼汾 (PH) 2007 Q2 法說會逐字稿

Good morning. My name is Paula and I'll be your conference operator today. At this time, I would like to welcome everyone to the 2007 second quarter earnings release teleconference. [OPERATOR INSTRUCTIONS] Thank you. I would now like to turn the call over to Ms. Pam Huggins, you may begin your conference.

Thank you, Paula. Good morning, everyone. This is Pam Huggins speaking. I'd like to welcome you to Parker Hannifin's second quarter earnings release teleconference. Joining me today again is Chairman and Chief Executive Officer, Don Washkewicz, and Executive Vice President and Chief Financial Officer, Tim Pistell. Again, before proceeding to the earnings release, just let me take care of a couple of administrative matters. As customary, I want to call your attention to the second slide, which is the disclosure on forward-looking statements and again, ask that you read it if you haven't already done so. Moving to the third slide, this slide indicates that in some cases, in order to provide meaningful comparisons from period to period, non-GAAP financial numbers have been used. These numbers, however, have been reconciled to the appropriate GAAP numbers where applicable.

Moving to the agenda, prior to moving to the agenda though I just want to say that for those online you may follow along with the slides that have been presented and if you're not online, the slides will be posted on Parker's website at phstock.com. Now, moving to the agenda. First of all, Don Washkewicz, the Chairman and Chief Executive Officer, he will provide highlights for the quarter. That's the first item. Secondly, I'll follow Don, going through the performance for the quarter and cover some key performance measures, and I'll conclude with the update on the outlook for fiscal year 2007. The third part of the call will consist of our standard Q&A, and once again, please, I ask, limit your questions to one at a time. I want to give everyone a chance to participate. For the fourth part of the call today, Don, he'll wrap up with some closing comments. So at this time I want to turn it over to Don and ask that you reference slide Number five and he will talk about some of the highlights for the quarter.

Thank you, Pam, and good morning to everyone that's on the call. I'd like to take this opportunity to wish everyone a Happy New Year. Just a couple comments, a few comments before Pam gets into the more detailed discussion and review of our second quarter. First of all, just like to say that we're obviously very pleased that we're able to deliver another record quarter and first half for our fiscal year. We're certainly on track for another record year at Parker overall, and I want to thank the entire global team for the continued execution of our Win Strategy. Some of the key highlights for the quarter, just to highlight for you, we set another record for second quarter sales at $2.5 billion and now, that implies a $10 billion pace, even with the -- the second quarter's typically our weakest quarter so we should comfortably exceed that $10 billion new milestone for the Company. Growth was 16%, which is well ahead of our 10% target for the Company, so we're very pleased with that. Acquisition and organic growth were each about 6.4%, which is about a 50/50 mix and that's higher than our 5% target for each of these both acquisition and growth targets, organic growth targets.

We're certainly very pleased to report our improved operating margin of 13.2% in the quarter, which is up significantly from 11.8% a year ago. And again this is traditionally our weakest quarter so 13.2% in our weakest quarter is a wonderful result. Our International Industrial segment generated nearly 80% more operating income than in the same period last year and it also achieved 13.2% ROS and we're extremely pleased with those results. Our strong cash flow enabled us to repurchase 5 million shares in the half and our first half cash flow from operations remains very strong at 307 million, which includes, I want to point out, a 100 million discretionary pension contribution, so we are still generating very very nice level of cash flow in the Company. Just a couple comments on markets and we'll touch on this probably a little bit more throughout the call. Distribution, I'd say overall, remains pretty strong and that represents about half of our Industrial business for the Company, so we're very pleased with what we see coming out of that segment of our business.

Our North America OEM markets are moderating and that's pretty much as expected. We expected them to moderate and they are doing that. The good news, I think, when you look at the overall economy and what's happening is that the Fed discount rate has stayed 5.25%. If you remember the last go around, when we were going into a little bit of a slowdown, the Fed was raising rates almost every quarter every time they met, where this time it looks like they're having a little bit more restraint and I think that's going to bode well for the overall economy in the coming months. Our International Industrial business, in addition to our Aerospace business, when you add those two segments up together, they make up now over 50% of our sales and the trends for these two segments look strong for the foreseeable future. And the last comment I would just make is that keep in mind that we have about a two month visibility in Industrial backlog and about a one year or thereabouts visibility in the Aerospace segment of our business. So, with that I'll turn it back then over to Pam for a little bit more detail.

Thanks, Don. Turning to the sixth slide, beginning with earnings per share, you can see that earnings per share on a GAAP basis for the quarter came in at $1.64 versus $1.07 in the second quarter last year, that's a 53% improvement. Moving to slide seven, the strong earnings growth on a consolidated reporting basis in the quarter versus the same quarter year ago is the result obviously of increased volume and that's led by the Aerospace and the International segment. International was up 36% and Aerospace up 16%. It was also 190 basis point improvement in the gross profit, again led by the International and Aerospace segments. The increases in operating income were 79% and 43% respectively. And then of course lower other expense as a result of a deferred gain in connection with the divestiture. There was a thermal plastic's loss included in last year's numbers and then of course there was some currency gains and lower pension expenses along with some litigation resolution and of course higher repurchases in the quarter. These higher earnings were offset, however, by higher SG&A expense due to our innovation program, restructuring costs, although they were minor, $0.03 for the quarter, and then higher taxes as a result of increased earnings and the tax rate of 27.1%.

Moving to slide eight, looking at the top line sales for the quarter are up 16%. This is versus the same quarter a year ago. Sales coming in at 2.5 billion up from 2.2 billion last year. Of the 16% sales growth, 6% is the result of acquisitions, 4% due to currency, mainly the Euro, and then 6% is organic growth. Moving to slide nine, the strong double digit sales growth in the quarter, obviously is a result of continued Industrial end market strength and of course distribution remains strong. Continued strengthen in the commercial side of the Aerospace business, general Industrial continues to be strong, continued progress in our emerging markets and of course acquisitions. On slide ten starting with the segment information, specifically North America, core sales increased 1% in the quarter, acquisitions added another 2% resulting in a total sales growth of 3%. Operating income is 3% higher for the quarter versus the same quarter a year ago and margins remained constant at 14% , so really good margins in the quarter, especially for the second quarter of our year.

Moving to slide 11, International, core sales increased 12% for the quarter, acquisitions add another 14% and foreign exchange, mainly the Euro, added another 10% resulting as a total sales increase of 36%. Operating income for the quarter is 79% higher than the same quarter last year. Excuse me for a minute. I'm just having a little bit of trouble. As you can tell, I have a cold and so I just needed to get a kleenex, so excuse me for that. Getting back to Industrial International, operating income for the quarter, 79% higher than the same quarter last year and operating margins increased from 10.1% to 13.2% in the quarter, a 310 basis point improvement. The main driver of sales and operating income growth in the Industrial segment, again, our continued end market strength that I mentioned, the acquisition strategy, the one [fit] to the customer initiatives, higher production through current facilities and continued success of the Win initiatives. Moving to slide 12, Aerospace segment, operating income for the quarter is 43% higher on a 16% increase in sales and this increase in income on a quarter-over-quarter basis is the result of higher volume and a higher mix of commercial after market business. The higher Aerospace margin of 16.9% is an increase of 320 basis points from 13.7% a year ago.

Moving to slide 13, Climate Industrial Control segment, sales there increased 10% in the quarter, however, operating income decreased 30% versus the same quarter a year ago, and we'll talk a little bit more about this. There was some change in product mix in that particular segment. Of the 10% increase in sales for the quarter, 9% came from acquisitions with the remaining increase the result of currency. So now, move to slide 14 and talk a little bit about orders. Orders were strong during the quarter. I think that order growth provides for the confirmation of the expected strengthen in sales as we continue to look further into fiscal year 2007. And as you know, orders are stated as a percentage increase of the prior year without acquisitions and currency. In total, orders were up 6% in December. In North America, however, order growth was down 2%; however that was on top of a 13% growth a year ago and 4% 2 years before that, so I think that illustrates that order growth remains at a high level. Industrial International order growth in December was 17%. That's on top of 14% last year and 15% 2 years ago, so again , as you can see, orders remain at very high level.

The strengthen in the Industrial segment is the result that we talked about of distribution, General Industrial, mining, oil & gas, power gen, heavy duty truck, and the construction market. Aerospace continues to be strong both on commercial OEM and MRO. Orders were up 10% and that's on top of 13% a year ago and 25% the year before that. So just remember, Aerospace, however, due to the volatility from month to month is reported on a 12 month rolling average. Climate Industrial Control segment, order strength as anticipated has moderated due to seasonal energy efficiency ratings of the SEER mandate. Orders declined 1% in December but that's on top of 20% growth last year. So orders through the Parker distribution channels, they continue to be strong and as you know, Parker serves 1,200 markets, which helps mitigate the volatility in specific sectors.

So at this time I'd like to just move to the balance sheet. Parker's balance sheet remains strong. Cash on the balance sheet at quarter end was 157 million and we only had 225 million outstanding in commercial paper. Inventory is flat versus the same quarter a year ago at 71. Accounts receivable in terms of DSO flat again at 49 days compared to the same period last year. As Don mentioned, after making 111 million contribution to our pension plans, operating cash flow remains strong at 308 million for the six months. Of that 308 million, we used 115 million for CapEx, which was about 2.3% of sales, so as you can see the CapEx remains at a low level. Acquisitions consumed 160 million and share repurchases for the quarter were 197 million. As a result of this, that increased by about 374 million. However, on slide 17 you can see that the debt to total cap ratio is still low, below our goal at 25.9% and if you take into account the 157 million of cash that we have on the balance sheet, you can see that the debt to total cap ratio is 23.8%.

So now I'll just move into the guidance. The guidance as shown on slides 18 - 20. On slide 18, you can see the guidance by segment for sales and operating margin and on slide 19, we detailed the guidance on what we call below the line item. As I want to save time for Q&A today, I'm not going to recite the guidance detail by segment to you. However in summary on slide 20, you can see that we're taking up the earnings per share guidance from continuing operations to $6.35 to $6.75 and that's an increase from the previous guidance of $6.05 to $6.45. So please remember that the guidance or the forecast excludes any acquisitions that may be made moving forward in 2007. The segment operating margins in total are expected to further improve in fiscal year 2007 from 2006. So that's all I have right now, so Paula, if you don't mind, can we open the call for Q&A?

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Andy Casey of Wachovia Capital Markets.

Good morning, everybody.

Good morning.

A couple, well, first question, just a clarification on cash flow, just for the quarter. It looked like there was a negative delta if you include the working capital and then the other assets and liabilities. Is there something going on in working capital other than acquisitions?

Yes, there's inventory added as the result of the acquisitions. You can see that inventory increased and so the inventory gets included in there so what you'll have is the whole impact of the inventory without the whole impact of sales.

Okay. And then Don, if you could, on the mix of Aerospace, could you break out commercial, how that grew versus military? Thank you.

Well, obviously, the commercial OEM is the part of the business that's very strong, but Andy, you saw the high margins in the second quarter, that's because we did have high commercial after market. But even more than that, what's happening in Aerospace on those margins is we deferred some of the R&D. There's a deferral of the R&D on one of the programs that's going into the second half, but basically, commercial-military typically runs on a normal basis 50/50 and right now commercial is running about 57 - 43% on the defense side. And then from an OEM MRL perspective, typically it runs 55 - 45 and it's running 61% on the OEM side versus 39% on the MRO, but the MRO in the second quarter was higher than we expected. Does that help?

Your next question comes from the line of Steve [Bolkman] of JP Morgan.

Hi, good morning.

Good morning.

I just wanted to ask a little bit about acquisitions. It seems like you've sort of stepped up the number, if not the total dollar amount in recent months and I just wanted to know if you're seeing a change in what's going on out there. Are people more willing to sell since we're seeing a bit of softness in North America? Are you seeing any change in what's happening with valuations?

This is Tim Pistell, Dave, I would say we -- I'm sorry, Steve, excuse me.

That's all right I've only known you for ten years. [LAUGHTER].

Yes, I'm sorry, Steve. But we had -- as you know, we had a very busy year last year and acquired about almost $1 billion worth of revenue. We took a bit of a breather I'd say over the first half of the fiscal to digest some of those, but we, once again, I think are back in full gear. All the groups are and they're quite busy, so it's good to see that we are doing quite a number. They are the smaller tough-on versions, tuck-in, bolt-on which are frankly the easiest for us to integrate and probably realize some of the early synergies from there, so I would say there's a bit. Also, Steve, I would say it's a bit of a seller's market. I don't think there's any question of that. I think the multiples are pretty high on some of the transactions and if I was not a long-term strategic holder and I had assets to sell, this might be a good time to bring them to market so that's probably part of the phenomenon as well.

Okay and then with respect to margins, especially International-Industrial, did the acquisitions help or hurt the margins in the quarter?

Yes. They absolutely did help. I think we have said earlier that our focus has shifted a bit and we really are trying to maybe pay a little more but bring on businesses that have higher margins and higher margin opportunities and I think that is definitely coming through.

Any chance you could ballpark how that helped in the quarter in that segment?

No. I don't think I could separate that right now.

Okay, thanks.

Yes. Sorry about getting the first name -- I don't know where my mind was, Steve.

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

Good morning, Ann.

Hi, good morning, guys. I guess the biggest change to your outlook is probably a slowdown in sales growth in Industrial North America. Can you just talk about what's going on there in terms of end markets? Are you finally going to see an impact from heavy duty trucks which was strong past quarter? Maybe you could just talk about that and then there was little or no operating leverage in that segment. Could you address that also, please?

Yes, Ann, this is Don. When you look at North America, of course, we anticipate it was going to soften and it has been softening and moderating over the last number of months here. Distribution though, which was I think I mentioned earlier, distribution still looks pretty good. To us it's still growing. Of course it's at a lower pace than before but still positive for us. Heavy duty truck, interesting enough right now, is still looking fine. Now we anticipate within the next several months here that that will probably start dropping off more around the fourth quarter unless there's a further push out of the activity there or ongoing activity I'd say in that segment, but that is still doing okay with respect to activity levels that we have on the books right now. I would expect that probably to start dropping off though in a few months. SemiCon right now is doing fine. It seems to be doing okay. Again this is is one of those short cycle-type segments for us but right now it seems to be in favor and doing okay.

We mentioned most of the OEM, other OEM markets are softer. We mentioned the refrigeration already because of the SEER. I think we saw a lot of the ramp up of the SEER 13 last year and we're feeling a little bit of the offset to that this year, so almost you have to look at the two years combined to get a good sense of what's happening in the refrigeration part of the business but we expect that to recover, going on out we expect the refrigeration to get stronger. Automotive still soft and we anticipate that to continue soft for the foreseeable future. With the housing starts, of course, impacted, construction has been impacted. We certainly see that in the order trends, again most of the OEM activity has moderated in those accounts as well. And then maybe the other two segments would be turf and forestry. That would be maybe a little softer than what we had seen in the past so flatter segments might be ag, as far as specific OEM segments, but that's kind of -- that will give you a little color on some of the major, the bigger segments that we would serve. The positive news though in all of that is really the nice improvement on the or increase on the distribution side.

Don, can you define what you mean by pretty good in distribution? Are you seeing any weaknesses in specific regions?

No. I'm talking in aggregate, Ann, and I look at the 312 and the 1212 numbers and it's still looking positive for us, growing of course at a slower rate than they had been but still growth mode which is positive, but I wouldn't be able to break it down by region because every distributer serves so many different markets, it would be hard by segment to give you any breakdown that's more meaningful than that.

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

Hi, good morning.

Good morning, Jeff.

Just wanted to go back to the Aerospace margins. Clearly, you've had great performance for two quarters and I think you suggested last quarter you thought that commercial MRO mix or maybe there was some military spares in there would go away and you see the margins come in. Clearly, your second half guidance suggests considerably lower margins than the first half, so I just want to understand that R&D deferral a little bit better and how you're thinking about mix differently within the context of the margin guidance, and also if you could just give us a sense of share count going forward as well in light of the share repo.

Okay. Starting with Aerospace. In terms of the R&D, it's basically a deferral. As you remember we said that R&D was going to be a little bit higher this year and we had talked about it being about 10 million higher and what is actually happening is some of the expenses are being deferred until the second half as a result of the delay of the A-35O program. So, that's what's happening there as well. Plus there was a spares contract for the Blackhawk and Apache that has come to an end. It was a contract and it's come to an end and so as a result you can see that's what's happening in the second half. That's about all I can say about that.

Those are the major two items that's causing that to be less in the second half. Now, if things are better, if the after market is better than what we think then obviously we'll do better but that's based on what we see today. And then in terms of the share recount, what you see are the share count going forward, what you're seeing is the share repurchases that we did that's impacting that number. So if you take the share repurchases, it's just basically been restated for that moving forward.

So what's the quarter end share count?

We're using about a 119.

Okay. On a diluted basis?

Yes.

Because that's higher than the average for the quarter, is that right?

Yes. It's a six-month average.

Okay.

Jeff, this is Tim Pistell. The six-month average on a diluted basis is 119.1, for the quarter it's 117.9.

And the ending count is higher than that 117.9?

Again, I --

I was just looking for the quarter end share count.

Yes, I don't know the actual quarter end number I do not have.

Okay. And then back to the deferral. So the second half of the year R&D is going to to be 10 million higher than the front half of the year?

Well, Jeff, originally when we came out we said that R&D was going to to be 10 million higher. This year versus last year.

See right now, Jeff, we have that pushed out, as you know the program was pushed out. Right now we have that pushed out into the second half and of course we'll just have to wait and see from there. That all could be incurred and expensed or that could be pushed out again. But right now, we have that put into the second half.

Your next question comes from the line of Mark Koznarek of Cleveland Research.

Hi, good morning, everybody.

Good morning, Mark.

I am going to try again Ann's question on North America, because it seems like that's a pretty significant revision in terms of your outlook, because if you look at where you were a quarter ago, we were thinking that revenues in North America would be up around 4% and now we're looking at up 0.5% and you include your acquired revenue in there and so if you subtract that out, it really means the core is down about 2% as opposed to your prior outlook was up around 1 or 2%. So and as Don stepped through all of those markets, it sounded like we heard pretty good words, language like that pretty often. It sounded like things were not too bad, so can you talk about where the delta is? What's different 90 days later than where we were?

Mark, this is Don. I hope I didn't mean to make things look better than they actually probably are out there. I think when I said that most of the OEM markets are moderating, they're actually when I say moderating that's coming down so most of the market segments are not growing necessarily on the OEM side of the business. I think what's mitigating that somewhat is the distribution side of our business, which is also moderating slightly but still is maintaining a positive growth over the prior year, so I think what you're really seeing is the OEM piece of the Industrial North America business which is, which we expected to drop off is what's being affected the most here.

So clearly, mobile equipment is soft, Automotive --

That's correct.

And then ag and construction, but then you've got a fair amount of capital spending related sales, and it seems like that market broadly is still pretty positive.

And some of that would come through the distribution channel. A lot of the in-plant, spending and things like that and not that I'm not talking OEM side as far as machinery necessarily but even some of our distributors do serve some of those small OEM-type businesses, but that's what's really probably keeping the distributer segment busier than what we had anticipated there even, just six months ago.

Okay, and then just to clarify the outlook from an EPS standpoint, we're up $0.30 a share from where we were a quarter ago.

That's right.

But on contributing to that is $0.09 of this R&D related tax benefit and then your other income and expenses, $0.14 better.

Correct.

So really, the sort of core business we're looking at $0.07 better, despite the fact that North America's a lot weaker?

That's correct.

Okay. Just want to make sure I got that straight. Thank you.

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

Good morning, everybody.

Good morning, Rob.

Good morning, Pam. I just first before I ask my question, I wonder if I could get Tim to clarify something you said to Steve earlier when you were talking about acquisitions in the International Industrial segment. It wasn't clear to me whether you meant to say that acquisitions in recent quarters and years are positively contributing to the margin potential in that business and we're starting to see it now or were you saying that acquisitions done in the past 12 months have actually been additive to margin in the quarter?

What I was saying, Rob, was that the acquisitions that we have made Internationally recently have been higher margin businesses and so they have helped in improving the margins in rest of world. Up to this date, they have been a positive contributor and we -- the potential for them in the future looks quite bright as well.

Okay, thanks, Tim. That was very helpful. My question is whether we can get you to size for us this collection of unusual other income and expense offsets that you had in the quarter, the deferred gain and the pension, litigation, how much is all that together?

I'm not sure how much it is altogether. I can tell you that the -- this is Pam speaking, Rob. Because there's various components of it but litigation resolution I think was around 6 million. Well the deferred -- and there was a deferred gain on the divestiture which was around 6 million as well. But you know there are lots of things that go into that particular segment. There's currency and as you know currency was favorable. There's lower pension expense in there.

Right.

So there's a lot of components that really affect the other category.

How big was the thermal plastic's loss in last year's number?

11 million.

Rob, I think the easier way to do this is just looking at the consolidated income statement that you have in front of you for the quarter.

Yes.

You can see there's a roughly 6.8 million credit there in other and that is pretty much all that deferred gain on the divestiture and if you look in the year earlier, there's a 10.9 million, that's pretty much all the loss on that thermal plastic divestiture.

Oh, okay. And the rest if it kind of nets out?

Yes. Those are pretty pure numbers right there in that and I'd say Pam hit on the other major component, one of the other major components there is we have definitely pension was a reduced expense year to year. That definitely helped and of course currency goes there and currency is in our favor as well.

So the pension thing should continue to be a benefit, right?

Should be, absolutely, yes.

Okay, the other items not?

Yes, you never know on currency clearly.

Well of course, right.

Right.

Okay, thank you, very helpful.

Okay.

Your next question comes from the line of Jamie Cook of Credit Suisse.

Hi, good morning.

Good morning, Jamie.

Hi. My first question relates to your guidance on the rest of world Industrial.

Okay.

Just if you look at the margin improvement that you've shown in your first and second quarter, it was pretty substantial, up about 150 basis points in the first quarter, up about 300 or so in the second quarter and then you look at your implied margins for the second half of the year. We're just not seeing very modest improvement but under 50 basis points or so, so I'm just wondering to me that appears conservative. Can you just help me out with how we're getting to those margins?

Well, first of all, I just want to address the sales too, because I want to make sure that everybody understands that we include acquisitions for 12 months. So when you look at the sales number for -- I just want to make sure that everybody does understand that those larger acquisitions that we made last year will fall off to some degree, okay? So don't forget that. And then to address the margins, I mean, one of the things that you can see is that we did build some inventory in this quarter and so there's an expectation that inventory will come down hopefully in the latter half. So that has some impact.

Okay. And that's the biggest reason?

Right.

Okay and then I guess my other question, sort of flipping on the other side, is on the Industrial North American side. It looks like your implied revenue growth in the second half of the year is down to meet your full year guidance but your margins are holding pretty steady. So to me that looks aggressive unless I'm missing something.

Well let's hope not. [LAUGHTER].

Okay.

Let's hope not.

But there's nothing unusual in there I guess that I'm missing?

No.

So holding margins on declining sales.

Right.

Okay. All right I'll get back in queue. Thanks, guys.

Okay, thanks, Jamie.

Your next question comes from the line of Alex Blanton of Ingalls Snyder.

Hi, good morning, Pam.

Good morning, Alex.

Just a request before we start, I noticed that the conference call operator is cutting some people off before they finish because they have no opportunity to say thank you. Would you please ask her not to do that?

Sure.

So that we can continue, complete our dialogue with you on the questions each time? I've got a similar question to Jamie's only on the total earnings. You earned 339 in the first half and your guidance for the year implies 296 - 336 for the second half. So that would be highly unusual to have earnings down in the second half. In fact, I followed the Company since 1973 and I can only remember that happening during recessions, to have the second half below the first half, and yet your entire range for the second half is below the first half. Now, I understand there's a $0.09 benefit in the first half, so it's 330, so conceivably, you could be up a few pennies and be within your range, but this is highly unusual. Usually the second half is quite a bit stronger than the first half. Could you comment on that and why you've chosen this range?

Alex, this is Tim. I think that, again, there's two adjustments for the first half. You caught the 339 and we have already covered some of the detail earlier. There is $0.09 on tax and of course there is the $0.04 there from the gain on the divestiture. Okay?

Yes, but you have restructuring charges in there too, so -- .

Well, we don't -- the restructuring we think is part of just normal operations. We have restructurings this year and we had restructurings last year and we have restructurings every quarter as we go along. So, they're really -- and frankly, it is not much different from quarter to quarter, year to year anymore. So I think that you have to really in fairness take those two out and so it's really a 326 for the first half. And then we do have a increased second half and I don't want anyone to go away with any misconception here that we don't have an increase in the second half. We do. Is it dramatic increase, the same as we had in the first half, no, it's not, because we have said that we covered this. We think that North America is definitely moderating. We'll be slightly down top-line. The good news that we'll have the offsets in rest of world and Aerospace, etc, But it's an up second half. Is it dramatic? No. But it's not dramatic because of what we've already covered.

But the low end is not up. The low end of your range is not up. It's not.

All right well --

296? Versus 326.

Well, Alex, I hope we don't hit that number.

Yes, I hope so too. Second question is this: You've gained share in rest of world in Aerospace because you have a 14% real growth in Aerospace and 12% Industrial rest of world. Orders for rest of world have also been very strong. They've been up 15.2% average for the last five months, 15.4% versus about a 2% average in North America. Is this because you were gaining share and is that because you have better on time performance, better ability to deliver faster than your competitors? This is something that you started seeing and telling us about two to three years ago. Is this the result of that gaining share, these really strong real growth numbers?

Alex, I think you have to kind of go back as to what we did in Europe with these what we call, and if you look at that Win Strategy, it's down there in the center column is that we call European initiatives, and a big part of the activity there in trying to improve what we were doing in Europe and getting those margins up had to do with how we're organized in Europe, and specifically, how we organized our sales effort, how we -- and now we've got to major sales companies in the big three countries which we did not have before. We were operating as independent groups, vertical groups if you will in all of those major countries, UK, France, and Germany. In the past that did not do much for us, okay, as far as having a coordinated effort and having one face to the customer and having one Parker, so instead what we did is we organized different in Europe.

We reorganized the sales effort underneath one country manager in those big countries and I think we're seeing a big part of the improvement that we're seeing as a result of that, yes, we are more effective in the marketplace because the way we're organized and we're organized the way the customer wants us to be organized and that is to be able to deliver the entire range of product to him and where he doesn't have to see eight people out in the lobby, he can see one person out in the lobby speaking for pretty much total Parker. So, customer service is up as a result of that. The sales organization is much more effective as a result of that, and I know it's hard to put your finger on hard numbers to show up but the numbers are showing up much better and it's a result of a lot of that effort that went on. Hopefully that responded to that.

Your next question comes from the line of Ian Fleischer of Friedman Billings Ramsey.

Hi, good morning.

Good morning.

Just a question, the value-added tax, the VAT tax in Germany increased on January 1. I'm just curious if you have seen or anticipate seeing any moderation in Germany from that increased tax rate.

Well, it's a good question. And I don't -- I think the jury is still out. That's all I can say. I mean, I think there was a lot of concern that it would really cool things off, the other people writing that it won't and I just think it's too early for us to judge.

Okay. And maybe touch on which countries were strong in the International Industrial businesses.

All of the Nordic countries are very strong. The Nordic countries are doing really well. Germany is doing well. Italy, you know, Italy wasn't doing as well but is doing very well for us now. So those are the major ones, Germany doing well, all of the Nordic countries and then of course Italy.

Any particular weak spots?

France isn't doing as well for us. UK is doing okay but France, out of the big three, Germany, France, the UK, France seems to not be as well as the other ones.

Okay, great. Thanks very much.

You're welcome.

Your next question comes from the line of Robert LaGaipa of CIBC World Markets.

Hi, good morning.

Good morning, Bob.

Just had a couple questions. One, just to circle back to the International Industrial segment, you mentioned an inventory build in the quarter. Can you just talk about the reasons behind that build and also looking forward, is it something that's going to affect the margins for both the March and June quarters or is it something that we're just going to see have an impact in the March quarter?

Bob, Tim. I think that the inventory build really is quite logically, you look at the order rates we've been seeing over there and as you can see, they've been quite strong. So as we pride ourselves on premier customer service first and foremost and in staying up to the delivery levels, I think that was just led to a natural build. That helps results, needless to say, as you're doing that. The key is to not let it get carried away over shoot where you want to be here and the good news is that the days in inventory seem to remain in balance where we were before. So that is what has occurred there. It was just a natural result of the increased orders.

Sure, and how much of a benefit would you say it had in the December quarter and again, what type of impact are you expecting moving forward? Is it going to have more of an impact, of course, in the March quarter? Is it going to be fairly evenly distributed in your view both in the March and June quarter?

I would say that again, it's difficult to quantify that. We know it's a plus to us. We haven't really tried to quantify that. I think what we're trying to do now is stabilize those inventory levels and make sure they don't get out of check and if that's the case then it will be neutral. It will only become problematic as we've got to watch here in North America, if the orders start to soften just a bit, then you got to make sure you gear your production down so you're not building inventory for quarters that aren't there. But I'd say right now, it was a help in the first half but really wasn't the major cause of their great performance, the great performances really done on operating issues, and I would say it's neutral here in the next few quarters.

Okay, terrific. And last question if I could, just on the Climate Industrial Control segment, can you provide a little bit more color on the margin, on the impact in this past quarter and the path to the increase moving forward?

Well, let me just maybe carry on. I think the first quarter was a great quarter for fiscal year for them because they still had a lot of the benefit of the SEER 13 and of course, that disappeared on us so that was problem Number one. Number two of course is the big three Automotive here as we all know are suffering and we have therefore undertaken some actions to try to mitigate that going forward. Now, those programs are in place but they have not all been fully executed and so we're not seeing all of the benefits of that coming through. So having said all of that, it was a great first quarter, tough second quarter for them but they're stepping up to it and we would expect that over the third and fourth quarter we'll see recovery both from the SEER 13 and also some of the results of the actions they are taking.

We have time for a couple more questions.

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

Good morning.

Hi, David.

Tim, the other expense there's some recurring items in there, there's some non-recurring items in there. What I just want to understand is in the next quarter what we should expect to be in there is pension expense, which is recurring, and what else which is recurring and somewhat predictable and how much do you expect pension expense to be in the next quarter?

Well, I think the one thing we don't expect to recur is the gain on divestiture of the business, so I think we lose that 7 million or so. Certainly, the pension credits will be there and if the currency stays where it's at, we'll have some favorable currency there as well. But right now, I think about the only major difference we see is the gain going away.

Are you talking about between the December quarter and the March quarter or between the March quarter last year and the current March quarter?

I was speaking more sequentially there, David.

David, I think what you can do is pretty much take the guidance that we've given you and subtract out the expense year-to-date and divide by two.

I got you, but what is pension expense per quarter?

Pension expense per quarter now has dropped down from around 13 million down to around 14 million. I mean 4 million, excuse me. 13 million down to around 4 million.

Now, remember, not all pension expense falls in that category.

Your next question comes from the line of Joel Tiff of Lehman Brothers.

How are you doing, guys? I didn't think I was going to make it. I wonder if you could talk a little bit about sort of the slowdown in North America and if you have any inclination of how long it's going to persist or maybe some of the factors that may get it to turn around in over the next two quarters or to keep it in place. I'm thinking more about inventory reductions and I'll just glue all of my questions together, so I can only ask one. And then can you talk about inventories in the channel, in the distribution channel and across other channels of your own product? Thank you.

Joel, we don't -- it's hard to answer your first question. The only thing we can take is because of our visibility on orders, we can basically give you some feedback based on what we're hearing from the customers. Difference what's happening now compared to what happened in the last slowdown, pretty dramatic. We're not hearing the end of the earth kind of scenario happening here, okay? This is more what I would consider, and we use moderating and I think moderating is a good way to describe it. It's not a crash and burn scenario for sure. We see that most of the OEM markets, as I said, are slowing down. We think that's going to continue through to this next half, of course. Impacting that a little bit more so then what we had seen in the past will be the heavy duty truck which will be toward the tail end of our fiscal year. Going on from there, it's hard to tell. I think, like I said earlier, what we thought was very positive was the fact that Bernanke, our Fed chair, has been restrained. That wasn't the case in the past. The last go around right now we would have been layering on more increases in the discount rate and driving this further and further in the hole.

I think we're coming in what I would describe as, and I know you've heard this terminology before, a soft landing. I think that's probably the best description of what I can see at this point in time. Could that change? Certainly could change. I don't expect it to change, but I think right now that's the way I would best describe what we see going forward. I think we'll give you more color on that quarter by quarter here, but the way it's been softening, it's been a moderation and it hasn't been a drastic drop off as we've seen in the past, so I'm encouraged. I'm encouraged. With respect to the inventory in the system, I think that typically the OEM's really don't carry much of our inventory, frankly, so when you talk about the inventory in the system, it's really Parker's inventory because we're pretty much on a just in time delivery kind of a program with most of our OEM customers. Our distributors I think are also as we've continued to deliver at higher rates as far as deliveries on time and we're at a pretty high rate right now.

They slowdown on their orders. They don't keep as much in stock but I think that's been going on all along. I don't think there's any major changes that we see right now compared to what we've been seeing all along. I think as we get better in our delivery performance, the distributors make the adjustments in their stock level. So that's kind of what I see. The OEM's don't have a lot in the system, at least the OEM's we deal with, and the distributors have been moderating their purchases according to what they see. Hopefully that answers those two questions for you.

At this time, I would like to personally thank you for attending the call. We appreciate your interest in Parker Hannifin and I'm going to turn it back over to Don. He has a few closing comments. So thank you.

Thanks, Pam. Well just needless to say, we're off to a terrific start for the fiscal year. I think you heard all of the numbers. We're very very delighted with the results of the year. Just a couple additional comments. I wanted to first of all thank everyone for their attendance and the time and questions that you had. The results we are achieving are a direct result of the execution of our entire team, our global team, on the Win Strategy. We continue to say that but that's exactly where the majority of this improvement is coming from. We're going to try to show through this cycle a very major change from what we've had in prior cycles and I think time will be our judge here as to how we do. But we're certainly off to a good start. And we're going to remain focused on executing this strategy going forward. Our emphasis, as it has been all along, will continue to be on maximizing return on invested capital and the goal there, as I've said time and time again, is to maintain Parker at the top quartile position relative to our peers. We continue to be focused on that throughout the entire organization and that will be an ongoing effort as well.

Some metrics maybe to remember, we are increasing our guidance. I know we had a lot of discussion here about guidance and all that and quarters to halves to year-to-year comparisons, but if you take the mid point of what we had, which is 6.25, we're raising that to 6.55 that should be good news for everybody out there and we continue to generate strong cash flow. I think that's the other positive. We generated about $307 million this year, year-to-date , and that was before the pay outs to the employee pension funds, which was I think around 111 or so million, and then the real key point to remember is the income from continuing operations and earnings per share reached a record for our second quarter, up over 50% over last year. So I mean, we're off to a very very nice start this year and we're pretty excited about that. Once again, thanks for your participation. We certainly appreciate your interest in the Company and in Parker and our success and if you have any further questions as the day goes on, Pam will be here the rest of the day to hopefully answer any of those that may come up. So once again thank you very much and have a nice day.