派克漢尼汾 (PH) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the first quarter 2008 Parker-Hannifin earnings release teleconference conference call. My name is Carma, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today, Ms. Pam Huggins, Vice President and Treasurer. Please proceed, ma'am.

Thanks, Carma. Good morning, everyone. This is Pam Huggins speaking, as she just said. I'd like to welcome to you to Parker-Hannifin's first quarter 2008 earnings release teleconference. Joining me today is President and Chief Executive Officer Don Washkewicz, and Executive Vice President and Chief Financial Officer Tim Pistell. Again, prior to proceeding to the earnings release, I want to address a couple of administrative matters. For those of you on the line, you may follow along with the PowerPoint slides that we've presented, and for those of you not on the line, the slide will be posted on the Investor Relations portion of Parker's website at phstock.com. Again, as customary, I want to call your attention to slide 2, which is the Safe Harbor disclosure on forward-looking statements, and again ask that if you haven't read this, would you please do so. Third, moving to slide 3 -- this slide, again, as is customary, just states that in order to provide meaningful comparisons from period to period, non-GAAP financial numbers have been used, and that these numbers have been reconciled to the appropriate GAAP numbers.

Moving to the agenda, slide number 4, again the call will be in four parts today. First Don Washkewicz -- the Chairman, President, and Chief Executive Officer -- will provide highlights for the quarter. Secondly, I'll provide a detailed review, including key performance measures of the quarter, and then I'll conclude with the revised outlook for fiscal year 2008. The third part of the call will consist of our standard Q and A. Again, please, limit your questions to one at a time. We want to give everyone a chance to participate on this call. And for the fourth part of the call, Don will close with some final comments. At this time, I'm going to turn it over to Don and ask that you reference slide number 5 titled First Quarter Highlights.

Well, thank you, Pam, and good morning to everyone on the call. Just a few comments before Pam returns for a more detailed review of the first quarter. Well, needless to say, just talking about the first quarter, we are very pleased that we're off to a great start for the quarter, confirming our view that we should produce another record year for sales and earnings for the company. Just to keep in mind, this is the start of our fifth year in a row where we're projecting record results. We just finished in FY '07 the best year in the 90-year history of the company. To start off this strong is really gratifying to us.

Our results this quarter also highlight Parker's new balance. Our sales outside of North America made up nearly 45% of our revenue in the quarter and that really hasn't been the case in many, many years. I don't think ever, actually, where we had our international segment that strong. Today we have a better balance in sales and margins than ever, making us less exposed to regional economic cycles. In addition, our operating margins for our international business was a record 16.7% in the quarter. And as you know, I think many of us have been talking about this for many years now, that this has been a seven-year work in progress. Our European team has been working hard on this over the last seven years and have done an excellent job executing our comprehensive margin improvement strategy over that seven-year timeframe. So that's all the culmination of all that hard work and effort that we're seeing today. We're also pleased with the ongoing growth in Europe and elsewhere outside of North America. We see continued strength there. Organic growth in our international sales were up over 12% this quarter. Lastly, our earnings per share up 13.7. I believe you've seen that. Organic growth continues to be healthy at 3.3% this past quarter despite some soft markets in North America. And really all of this success really for the company is being driven by our employees' continued execution of the win strategy. Of course that's our road map to operational excellence and growth.

A couple of comments on markets. Keep in mind that we have about a two-month visibility in industrial backlog and around a year of visibility on aerospace backlog. With that in mind, our orders are up 7% in total for the quarter versus a year ago, with particular strength coming from international, industrial, and also the aerospace segments. So those are the two real strong segments of our business right now. Distribution -- keep in mind distribution represents half of our industrial business, and it remains strong. So we're very pleased with our 12,000 distributors and what they have been able to do out there selling and representing Parker. Some of our North American markets are weak and have been weak as expected, such as construction, and some of this is tied into the credit crisis going on. Automotive, heavy truck, and so forth. Keep in mind we're setting these records in spite of this softness in these very key markets for us. So I think that goes a lot to our success as well. Our European markets continue to show growth through September as did our markets in Asia as well as Latin America, so we're optimistic about our ongoing future growth in the international markets that we serve. So with that, we'll turn it now back over to Pam for a little bit more detail.

Thank you, Don. So to begin with the quarterly earnings, please reference slide number 6 for those of you that are online. As you can see, earnings per share for the first quarter came in at $1.33. This is a 14% increase over the $1.17 in the first quarter last year. So what were the components of this earnings growth? On a segment reporting basis in the quarter, it is as follows. First, revenues in the quarter increased 9% due to international, industrial, and aerospace segments. Their revenues were up 25% and 6% respectively. Second segment operating profit increased by 8%. Again this was led by the strength in the international industrial segment with an increase in operating income of 44% for the quarter. Third, income taxes decreased 3% in the quarter due to the lower tax rates in Germany and the UK. And fourth, the shares outstanding were lower, mainly as a result of the accelerated share repurchase program.

Now, these higher earnings were partially offset by higher general and administrative expenses due to IT charges; higher interest expense, again, mostly the result of the share repurchase program that was financed with commercial paper; and then less other income due to the resolution of a legal dispute that resulted in income last year. So just to summarize that for you real quickly, operating income added $0.12, taxes added $0.04, lower shares outstanding contributed $0.06, again offset by $0.03 in general and administrative expenses, $0.02 in interest, and $0.01 from other income. So as you can see if you net these items earnings for the quarter were quality earnings. Clearly, the result of better performance.

Moving to slide number 8, looking at the top line and beginning with sales for the quarter -- again, as I said, they're up 9%, increasing to $2.8 billion from $2.6 billion last year. Of this 9% sales growth, 2.4% is the result of acquisitions, 3.5% is the result of currency, mainly the Euro, and 3.3% is organic growth. Moving to slide number 9, the strong growth in the quarter is the result of obviously continued strength internationally that Don talked about. The organic growth there was 12%. Latin America continues to show improvement, particularly in Ag and Brazil. The distribution in the commercial side of the aerospace business continues to be strong. Acquisition continue to contribute and of course Parker continues to make progress in emerging markets.

Moving to slide number 10 and focusing on segments, starting with industrial North America, the most notable thing on this slide is that in spite of some softening markets, the first quarter margin increased to 15.4% from 15.3% a year ago. Obviously this is the result of the successful acquisitions that we did, the diversification of our business, and, of course, execution on our initiatives. Moving to slide number 11, continuing with the industrial segment, addressing international -- noteworthy here is that currency is becoming a larger contributor to sales, obviously with the strengthening of the Euro and weakening of the dollar. But the organic growth at 12% for the quarter helped us achieve great margins of 16.7%, and this compares to 14.5% last year. And, of course, acquisitions added 4% to sales in this particular segment. So as you can see international continues to do well across the various markets with strength expected to continue into the foreseeable future. The volume improvement is broad based and reflects higher revenues in all regions -- Europe, Asia Pacific, and Latin America.

Now we'll move to slide 12, aerospace segment. Most noticeable on this slide is there was a decrease in margin this quarter, and that's due to higher costs in connection with development costs relating to the [procurement wins]. It should be noted, however, that the guidance for aerospace continues to remain at the original projection as this business continues to operate at a very high level.

Moving to slide 13, and addressing climate and industrial control segment, we've talked about this on several calls so I'm sure you're all aware of it, but this segment is coming off a very high year of SEER 13 sales. SEER 13, for those of you that don't remember, stands for Seasonal Energy Efficiency Ratings. So there was a high demand for these units that's fallen off as a result of a regulations change. This along with softness in automotive, heavy-duty truck, and residential air conditioning account for the decrease in sales and the reduced margins in the first quarter.

Moving to orders, we indicated on the last quarter earnings call that orders would be reported on a quarterly basis, and in connection with the earnings release each quarter. So in line with that, slide 14 details the orders by segment. These numbers, just to remind you, represent a trailing three-month average, and are reported as a percentage increase of absolute dollars year-over-year, and, of course, it excludes acquisitions and currency. Orders are up 7% for the September quarter just ended. Don mentioned that. The 7% is up sequentially from 3% last quarter and compares to 9% a year ago. So all segments of the business have higher order numbers sequentially other than climate and industrial controls due to the SEER 13 comparison. This increase in orders is despite of some softness in some of the markets that Don mentioned as well. So orders through distribution continue to be strong. North America -- they've improved sequentially as well from a negative 3% last quarter. They're flat year over year now. This compares to 5% a year ago. Industrial and international orders continue to gain strength increasing to 19% this quarter versus 14% last quarter and 14% last year. And, of course, this international strength supported by Asia, Latin America, as well as Europe.

Aerospace OEM and MRO continue to be strong in the commercial side. Aerospace orders are up 12% this quarter, and this compares to 8% last quarter and 18% a year ago. So aerospace orders continue to be very good. Climate and industrial control order strength, as anticipated, has moderated due to the high comparables. Again, as a result of the SEER 13, orders are down 13% for the quarter. This compares to a negative 6% last quarter and 6% a year ago.

I'll now just address the balance sheet briefly. Our balance sheet remains solid. Cash on the balance sheet at year end was $188 million, higher than it was last quarter, and -- but we have $382 million in commercial paper outstanding, mainly as a result of the accelerated share repurchase program. Day sales outstanding for inventory improved two days in the quarter from 68 a year ago to 66. Accounts receivable, in terms of DSO is up two days, however, coming in at 53 versus 51, mainly due to the higher sales. And the larger decrease that you're seeing in other assets and pensions and other post retirement benefits on the balance sheet year-over-year, just to remind you, is the result of the FAS 158. Slide 16 -- addressing our cash flow, you can see we had had very strong cash flow in the quarter at $269 million. This is another record for the company, substantially up from a year ago. Of this $269 million in cash flow, $56 million or 2% of sales was used in connection with capital expenditures. Acquisitions consumed $34 million, and of course the net share repurchases cost about $500 million. Dividends were paid in the amount of $37 million, and as a result of [this in more] debt increase by about $383 million. However, on slide 17, you can see that our debt to total cap ratio is 27.2%, providing the capacity to generate premium returns to our shareholders going forward.

Now I will address the guidance on slide 18. Slide 18 through 20 addresses the guidance. I'm not going to detail all of these numbers for you. You have them before you on the slides and can get them on the website. So at this time, on slide 20, let's just go to slide 20. And slide 20 summarizes the guidance on earnings per share from continuing operations. As you can see from the slide, the guidance for 2008 is projected to be $5.05 to $5.35. This compares to the previous guidance of $4.80 to $5.07. So it's an increase of $0.27 at the midpoint. Please remember that this forecast includes acquisitions made to date but excludes any acquisitions that may be made going forward. To provide just a little more color to the guidance to help you, the first half versus second half sales to net income are projected to be 49% and 51% respectively. So the revised guidance, just to help you a little bit, as compared to the original guidance released last quarter, it incorporates a slight improvement in sales due to industrial international, increasing operating margin, contributing $0.13 to diluted earnings per share. Again, due to the strength in industrial international, a lower tax rate contributing $0.08, lower shares as a result of the ASR contributing $0.16, and then partially offset by higher interest expense of $0.10. So hopefully that helps. At this time we will open up the call to our standard Q-and-A session. Thank you.

(OPERATOR INSTRUCTIONS) And the first question comes from the line of Joel Tiss from Lehman Brothers. Please proceed.

How are you doing, guys?

Good morning, Joel. How are you?

All right. I wonder if you can get a little more specific. You referenced three or four times Latin America and Asia were strong. Can you give us some percentages and idea of what "strong" means?

Well, when you look at the orders -- when you look at the orders, you can see that international, the orders have gained the most strength there. Yes, that's caused by Asia and Latin America, but the biggest portion of our business is in Europe. And so obviously, that's the biggest portion of the increase in orders. So Europe remains very strong for us going forward.

Joel, this is Tim Pistell. The orders in all three of those areas continue to run up double digits. There really isn't much difference between them.

Okay. That's helpful. And can you also give us a sense of the improvement in North America from negative 3 to 0? Can you give us a sense of what's behind that? Thank you.

In North America, while we said that it's been soft, the oil and gas continues to be very strong. General industrial continues to be very strong. Power gen -- in fact, power gen is extremely strong for Parker-Hannifin. And, of course, our distribution continues to be very strong.

Those would be the main ones.

Okay, thank you.

Thanks, Joel.

And the next question comes from the line of Ann Duignan of Bear Stearns. Please proceed.

Good morning, Ann.

Hi, guys, it's Ann Duignan here. Just a followup on that -- on the aerospace, development calls, are they done or do some of them roll into Q2?

Ann, I'll answer that for you. On the development costs, I think if you'll recall from the last quarter, we had said that development costs -- we're not expecting those to rise significantly. What's happening here is we just have a timing difference between the first half of the year and the second half of the year. So it's really just a timing difference in the way that it's -- it's not evenly flowing throughout the year.

So more impact in the first half?

Yes, and that's the reason that the guidance is staying the same. It's because it really doesn't have an impact on the year. It's just first half versus second half.

Could you give us some color on where you're seeing the strength in North America in the distribution sector? That's an area that I would think would be pretty coincident with economic activity. We're hearing from pretty much from everybody that economic activity is kind of a concern out there right now. Don, can you give us some color on what you think is driving the strength in the distribution business in North America?

I think it's just -- Ann this is Don. I think that when we look at our distribution it's primarily coming from the industrial side of the business, which is pretty broad-based. There's still a lot of activity going on out there, even though the orders aren't really ramping up a lot, people still have to maintain a lot of the equipment that's out there. So the level of activity is still pretty strong. It's more so on the industrial side than it is on the mobile side right now.

Ann, this is Tim. If I could add a little more, the markets that are soft, that we all know are soft -- the big three auto, heavy truck, and so forth, and the construction people -- they handle a lot of their aftermarket themselves. Our industrial -- our distribution is, as Don said, more of the general, broad industrial area, and that's still doing quite well.

Okay. In the interest of time I'll get back in line, but just wanted to say I was on your Parker-Hannifin bus the other day at a trade show, and I really think you ought to bring that one to New York sometime.

Okay, thank you.

Thanks for that comment, Ann. Thank you.

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

Hi, Mark.

Hi, it's Mark Koznarek. I have a question about the revised outlook, especially on the revenue line. It looks as though -- especially the industrial businesses -- when you adjust for, as you say, the acquisition revenue that's already in there, and then for international you also add the currency benefit that you already have in the first quarter, is that correct?

Right.

Okay. So what it means, especially for both of those is there's virtually no change in your core revenue growth outlook, like North America is still a little less than 1%, and international is still right around 7, slightly above 7. And the international really sounds like that ought to be higher, given the strong start you've got and the 19% orders growth on the international side as well. So could you discuss whether you expect significant slowdown coming, especially in international, or whether this is just a conservative outlook?

Yes, Mark, maybe I could answer. This is Don. I would say that, no, we don't expect anything negative from international. The guidance -- keep in mind that we have like two months worth of backlog that we're looking at on the industrial side of the business. And we'll have more quarters to give you more clarity on the outlook, so I think this is just -- hey, taken what we see today, both the hard numbers, the orders, as well as the anecdotal information we're getting from our customers, and giving a good snapshot of that today, which, of course, we're going to be updating every quarter anyway, and just giving our initial look. Could it be better? Certainly it could be better. You obviously have picked up on the fact that the orders look better international. We don't anticipate anything negative on international. We've heard a it lot and read some companies talking doom and gloom out there. Frankly, we don't see it anywhere. So I don't know what markets they serve, but we obviously are serving other markets if their markets are soft. Ours certainly are not. They're doing very well and we anticipate that will continue. So the other thing that I think will be positive going forward is the fact that we've had -- and nobody really talks about this I don't know why -- but we've had a discount rate reduction in North America. And interest rates may go up in Europe, but the discount rate reduction in North America I think is a big positive that is not going to impact us today and never has initially. It takes about six months. So looking into the second half, we would hope to see a little bit more pickup in North America as a result of that. Surprisingly, nobody talks about it, though. And maybe because it doesn't have an immediate impact. So I think that there's some positive upside, both in North America, and I don't see anything real negative going on elsewhere around the world. Everything that we see is positive. So hopefully that gets to your question, Mark.

Mark, just to address the numbers a little bit, I just want people to understand that the actual numbers in international as you progress throughout the year are going up. Second quarter, which you well know is our worst quarter, and so things aren't as strong in the second quarter as the first quarter, but the actual numbers for international really are going up. So I just want to make sure that that gets across. Thanks.

What's notable -- I'm just going to leave it at this, because we can talk offline, but the comp in international on a core growth basis is really pretty even throughout the year. So you don't have a dynamic of tough comps. So it does seem like we ought to be seeing improvement as time goes on here. So I'll leave it at that.

Okay.

Thank you.

Thank you.

And the next question comes from the line of David Raso from Citigroup. Please proceed.

Good morning. Quick question on the sustainability of the international margins. I recognize the seasonality of the first quarter, but to see the international margins ahead of North America is obviously the most noteworthy aspect of this report. Can you help me understand, and to the prior question -- fundamentally you are guiding international core growth to get cut in half the rest of the year versus what you put in the first quarter. If you're saying that's not really the case, and it is what it is, but can we think about how margins in your mind can be internationally looking out the next year or two and especially the next three quarters versus what we saw in the first quarter? Down again because of seasonality, but the idea of being above North America for an extended period of time?

David, Tim Pistell. As Pam mentioned, and as you know, this -- what's happened here the last couple of years, first quarter is a pretty good one for us in international. Then, of course, there's a drop-off in the second quarter with the holidays, and then we kind of come back up in three and four. Our target all along has been to get international to a 15% operating margin. That is the corporate goal for all the segments, and I think that's clearly what we are going to be working towards in international, and then we get there, then we'll see if we move the goal line again to try to crank that up a bit. So it is going to be a bit lumpy here, but I think that's what we're looking at. And I think the issue, as we've already said, is that we'll -- with what we know and what we have on the books, we have a reasonable good probability of -- on the second quarter. And then the third and the fourth quarter, have to really wait to see how they shape up. I think, as Don said, we think that with what's going on in the interest rates around the world, we could -- could be some concern that Europe would slow down a little bit, increase at a decreasing rate. But North America would start to pick up again. But overall the sustainability of the margin, we're heading towards 15 and we hope to sustain that.

Not to make this a long-winded discussion but obviously -- Tim, back in the '90s, we used to talk about the SG&A inherently was always so high in Europe, you just really had a tough time getting North America. Obviously all the distribution moves you've done and how salesforce themselves -- multiple Parker lines to one customer -- it's obviously played out very well and obviously the currency has helped as well. But I'm just trying to fundamentally understand -- given aerospace, North American margins, international, the idea of your earnings power the next couple of years to not just make it another top-line story, the idea of getting margin improvement. It's tough to see North America up, tough to see aerospace ever getting back to where it was that one blip year in the late 90's around 18%. So it's the international division that I think is the unknown -- can this get to a couple hundred basis points above North America? Sounds like you're not willing to commit to that right now. I know you can't obviously promise. But can you look at this business now the way it's configured to be? Well above North America?

We are not satisfied. We need to get to the 15 first, David, as you know. That's been a long target. And now we're just on the verge of doing that. And then I think that we can -- aerospace would be well over 15. We're still saying 15 for the year for aerospace, and they would finish the year well over that if they were not spending so much money on all the new programs. After some of that is behind us, we think you'll see aerospace above -- comfortably above 15 again. We plan to push on both in North America and rest of world. So -- very much so, we feel that these margins will be sustainable going forward.

Okay, I appreciate it. Thank you.

Right.

And the next question comes from the line of Jamie Cook from Credit Suisse. Please proceed.

Good morning and congratulations.

Thanks, Jamie.

My first, just to build on David's question, in the first quarter there wasn't anything -- there was no unusual gain or anything weird in the first quarter international margins. Just to be clear, there's nothing we should take out?

No, there's nothing.

Okay. And then just my second question -- even on the North American front in the face of sort of moderating markets, I was impressed with the margins that you put up in the first quarter, even better slightly relative to last year. So I guess sort of what's driving -- if you could just give a little more detail on what's driving the margin improvement in North America.

Well, Jamie, that's pretty much what we've been talking about with respect to the win strategy. Everything that we've been driving here has been really tied to the key initiatives, the procurement initiative, which is still going on strong, the lean initiative, strategic pricing, as well as our innovation. All of those key core initiatives that we've got are really driving the improvement. I know that I'm starting to sound like a worn record a little bit because I keep repeating that -- because there really is nothing else there that is -- that we haven't been telling you about. It's really tied all to the win strategy and the things that we're working hard on every day. Keep in mind that all of these are being driven from corporate. They are centrally led, and it's an ongoing process, so it's a never-ending process, if you will. And when you ask how do we add value in Parker-Hannifin, it's by executing on the win strategy, not only on our existing businesses, but executing on the win strategy on our acquisitions. We get -- we're buying better businesses today I think than we have in the past. We're executing the win strategy initiatives faster and getting those margins improved quicker than we ever have in the past. That's all part of the strategy. So it really all comes back to that.

On the strategic pricing front, North America -- you're still successful, not seeing a more competitive environment?

We're successful because we can deliver. The key is out there today, even in North America there's places where people are having a hard time getting product. As crazy as that might sound, there's still some market segments that there's a lot of demand. Fortunately we have been able to deliver. This holds true as well as in Europe. We've been able to deliver. Others haven't. If you can deliver -- people frankly want to ship product, and they can't ship product if their suppliers can't deliver. So we've been fortunate to have dealt with that situation very appropriately.

Thank you. I'll get back in queue.

Thank you, Jamie.

The next question comes from the line of Ned Armstrong from FBR Capital Markets. Please proceed.

Good morning, Ned.

Thank you, good morning. My question involved acquisitions. I wanted to know: one, what you're seeing in the markets out there, vis-a-vis pricing, willingness of sellers to sell, and also if you've identified other areas that you'd like to acquire in, in addition to the ones you've been focused on for the past couple years.

Ned, this is Don. There's still a lot that we're looking at today. Interesting maybe change of events of late is that we see a lot more of the private equity out there, more on a selling mode than in a buying mode, which is a little bit of a twist, a little bit of a change that we're seeing. But there's plenty that we're looking it at today. No, we are not getting off course as far as looking at other -- getting off on a tangent in any respect. We think there's plenty of opportunities in the space that we've identified here at Parker, these seven or eight core technologies, and we want to stay focused on those. But there's a lot that we've looked at. We did acquire a couple of small ones just recently. I think there's been a public announcement on another one that we're working on now, and there's plenty of other ones that we're also looking at actively. Nice thing about it is, with our leverage the way it is, even after that major share repurchase that we still have a lot of capacity to bring on additional volume, and we intend to do that.

Have you seen any willingness on sellers to be a little bit more flexible on the prices they've demanded these days compared to say, six, 12 months ago?

I can't say that I would say that we've seen anything major, only because most of the acquisitions that we've worked on, as you look in the past, have been privately held companies. And typically, they have not been as much an auction as maybe you would have expected with private equity involved and so forth. There have been some of those, but generally speaking we're working with privately held entrepreneurial companies. And they basically are just looking for a fair price for their company and a good home for their employees. And that's their main concern more than anything.

Okay, thank you.

Thank you, Ned.

And the next question comes from the line of Daniel Dowd from Sanford Bernstein.

Good morning, Dan.

Good morning. Congratulations on a terrific quarter.

Thank you.

I'd like to return to the margin issue in international industrial for just a minute. You guys have been working on a whole variety of initiatives for years now. I wonder if you could help us understand which things contributed to the margin improvement quantitatively if possible, qualitatively if that's the best we can do. But, I mean, what was the impact of pricing, the impact of raw material costs, all of your lean initiatives, the impact of operating leverage? How would you dimension which of those were really driving all of that improvement, and how would you expect to see that be the same or change over the next three or four quarters?

This is Tim Pistell. Let me go back to our -- or the middle pillar of the win strategy. We were out there, and we said that we thought that through strategic procurement we could pick up 2% margin. We thought with lean we could pick up 2%, and we thought with pricing that we could pick up 2%, and we could do that around the world. That was not geographically specific, and I think we have done that. Now, the other item in that column always was European initiatives. And as someone touched on earlier, I forget who brought it up -- it may have been David Raso -- so a lot of that was focused on the SG&A. We were pretty good through manufacturing margin, but we were just carrying too much SG&A. Why? Because we ran Europe like everyone always ran Europe, and it was all these little countries and languages and so forth, and wasn't in recognition of the EU. Well, the EU is here, the Euro [stock] and so we had to start running ourselves completely different, and we did a lot of things -- much too long to get into on the phone call here, happy to do it more in detail -- to really address that and reduce the overhead that we were carrying. So this came in the formation of sales companies handing multiple lines. It came in financial service centers. It came through distribution centers, a number of things, all of which to attack that SG&A, and we track it -- we track it actually by line item, and it really is working. And it's very gratifying for us, and especially all the people in Europe to see these real positive results. So a little bit of the three [wins] that you know so much about and and a lot of very specific attack on SG&A in Europe.

At the risk of beating a dead horse, the initiatives on the SG&A in Europe, are they 50% done? Are they -- basically you've gotten it all straightened out now and it's only sort of incremental improvements that are possible from here? Do you see a lot of upside?

Well, the broad-brush I'd give you is probably -- might be 50%, but that's not fair. Some are, I'd say, 100% complete, and some we frankly haven't even started much doing. So whether we're 50% of the way there or two-thirds of the way there, I really can't give you that. The other thing, and I will just want to touch on this first quarter, which with the margins being so extraordinarily good, again, first -- and the number one pillar in everything we do is premier customer service. Part of the problem in Europe always was it would shut down July and August, depending on the countries you were in. Well, that's not premier customer service necessarily. So our people have worked very hard in learning how to continue to ship to the customer, to the customer needs, especially when they're very busy over there, despite the fact that a lot of people may be taking holiday. If you can do that you will generate some very favorable returns. So that's part of this first quarter phenomenon that we're seeing in international.

Thanks.

Right.

Thanks, Dan.

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

Good morning.

I just had to follow up on the margin question. Clearly outstanding. I mean, clearly stellar. And I guess I just wanted to approach this a little differently. If we look at the fourth quarter sales in the international business, I mean, from the fourth quarter to the first quarter, the sales increase is only about 1.5%. Meanwhile, the margins went from, 13.2 to 16.7. So 350 basis point increase. I mean, what happened sequentially to cause that type of increase? Was there any currency in there that helped out the income? Was there mix from the June quarter to the September quarter? Can we just talk about this sequentially so we can better understand what happened?

Again -- Tim again -- nothing really extraordinary in it, and I think that the major issue here for us in the first quarter is that -- wonderfully, they managed to ship more in that first quarter than the fourth quarter. And again, because it's busy and people wanted the product, although we did that in -- in some reduced manufacturing, if you will, and again, it's just the good dynamics there, if you continue to ship to the customer when some of your costs reduce, you are going to have this good end result.

And was there any currency impact on the income? I know what it was on the top line.

I'm glad you asked. That what we do with Parker, we try to naturally hedge as best we can. Most of what we sell in the region we make in the region, so really, the currency effect I would say was relatively nominal. There could have been a little bit, but would have been pretty nominal.

Terrific. Very good job. Thank you.

The next question comes from the line of Alex Blanton from Ingalls and Snyder. Please proceed.

Good morning. Before I ask my question, Pam, just a suggestion that you probably ought to say the press release that the orders are before currency and acquisitions as well, because otherwise people are going to be comparing the 7% increase in orders with the 9% increase in sales and saying things are slowing down.

Thanks, Alex.

You didn't point that out in the press release. You did on the call, of course.

I think it's in the footnote, but I'll make sure that I look at that.

I see there is a note on orders, but people kind of skip that. Put it in the text.

That's a good suggestion. Thank you.

Okay. Now, again, going back to the margin guidance that you gave, slide 18, the guidance for the year for industrial North America is well below what you achieved in the first quarter. 15.4%. The guidance for international is also well below, and 16.7% in the first quarter. Aerospace, of course, is higher. And climate and industrial control is the same. But the biggest impact is the fact that on your large segments, you've got guidance for the year that's substantially below what you achieved in the first quarter in terms of margin. And I notice that Tim kept talking, we hope to get to 15% in industrial rest of world. Well, you're already there. So I didn't understand that at all, unless he was sort of pessimistic about the rest of the year and wondering if you could even achieve 15% for the other quarters. Because if you do, of course, you'll be well above it for the year. So could you elaborate on why your numbers for the year are so much below what you achieved in the first quarter? Typically the first quarter isn't that great. Compared with what you do later on in the year, second half.

Right. But, Alex, I think it's unfair a little bit, just to compare the first quarter to the year, because we do have that second quarter that's substantially below the first quarter, and it naturally pulls the average down.

Yes, and then you follow it by two quarters that are well above either one of those, usually.

Right. Alex, do you know, when you look at last year's guidance versus this year's guidance, we're giving over $0.50 improvement. So I think that --

A few years ago you actually added $1, so that's not that big.

The key thing, Alex, the guidance has gone up significantly.

Yes, it has.

Our outlook is positive. You will get another update in three months. We'll get another look at this and if the looks like the margins, could use a little boost upwards, we'll certainly do that. It's really what we see right now, and it's just the first quarter of the year.

But it implies that you're seeing something negative for the rest of the year.

That's the reason why we have the rest of the dialogue going on here. I wanted to make absolute certain people didn't feel that way, because we don't see anything negative. I've mentioned the interest rates North America coming down. That's very positive. That's extremely positive, especially for the second half. Irrespective of what happens to interest rates in Europe, this is a little bit of a teeter totter. So if the interest rates go up in Europe, and they go down in North America, who cares, I'm making a good margin everywhere. So if we lose a little bit somewhere, we'll pick it up in the other region. That wasn't the case not that many years ago. I used to -- I used to shake when our North American business went down, because we nod place else to make it up. Today we do. So we're in much, much better shape.

So, no, don't read in anything negative about our feelings about international business. We are bullish internationally. I don't understand what I've been reading in the press. We don't see it, we don't hear it anecdotally from our customers and we're not experiencing it. I'm positive about North America long term. I don't think in the next few months we're going to see much of a change but I think gradually you're going to see an improvement in North America. I think Bernanke is handling this thing absolutely perfectly compared to the way it's been handled in the past. So I'm very positive. I think the downside that we see is really comes from those -- the automotive, the heavy-duty truck, and the housing starts, which, of course, impact the construction in those areas. They have been soft, so we're going to live through that, and eventually those will turn around. I think the interest rate reductions will help get that moving as well in a positive direction. But right now we're just going to have to weather that, but we're doing it pretty well, and we're doing all of this and raising the guidance. So don't read anything -- believe me, I wouldn't be raising guidance if I thought something bad was on the horizon here.

Thank you.

Thank you, Alex.

And the next question comes from the line of Robert McCarthy from Robert W. Baird & Company.

Good morning.

Good morning, everybody.

How are you?

I'm fine. If you'll humor me a second, how about a shout out to Jack Myslenski, who obviously didn't do everything by himself but had a key role in getting your international margins to where they are today.

Thank you.

Thank you. We appreciate that. And he will too.

I wanted to follow up on a couple things that had been talked about before. First, Don, what you're saying about international, I hear a couple things and I want to make sure that I understand the message. You have limited visibility -- within your horizon you see nothing bad. Tim talked about the prospect that higher interest rates in Europe could potentially have a slowing effect in the second half. I think what I'm hearing is that, you don't think there's any danger to sort of the absolute level of business. Year to year percentage increases might moderate, but you think the absolute health of the market is very good. Is that --

I think you hit it right on, absolutely. I think that's right. And there's going to be a little bit of a to and fro here, and I can't call interest rates. They're going to go up, they're going to go down. Like I said before, frankly, I don't care where they go. When they're going counter to one another, we'll make it up in another region, as long as everything isn't going all down at the same time. So that's where you have concern. But I don't have any concern, frankly, if there's a little bit of moderation, if that materializes -- we don't know if it will, but if it does in Europe, right now we don't see it. We don't even hear about it anecdotally in our markets. But if it happens and we pick up in North America, we're going to be just fine.

Okay. And then I also wanted to follow up on -- I think it might have been Joel's question about order rates in North America improving to flat in the quarter from minus 3 a quarter ago. He asked about puts and takes. We heard about several markets that have been -- remain strong, quote unquote. But I didn't hear much about negative except light vehicle. Unless I'm mistaken, there isn't much auto in industrial North America. Heavy-duty truck and construction equipment.

Right.

Is there anything beyond -- I mean is the negative drag pretty much strictly heavy-duty truck and construction equipment? You're not seeing any weakness anywhere else?

Good question. Primarily heavy truck construction, light trucks, cars, residential air conditioning would be another area that would be soft as well. That I think is driven by the credit situation. They're not building houses, people aren't replacing their air conditioning units, they're fixing what they've got. Eventually that will change, but those are the soft segments right now. By the way, those key tough segments really do impact that CIC group directly. They're active in heavy trucks and cars and light trucks, and certainly in the air conditioning side, which is being impacted as well. So it's like all three key market segments are being affected by it.

The core of my question is, as we go from the minus 3 to the 0, is it a function more of the good stuff got stronger, or the weak stuff got less weak, and what does that tell us about what we might see in the next quarter? In other words, do we think we go from minus to flat to plus?

I don't know about the comps.

I think -- Rob, this is Tim, I just want to add -- and before I get to the pluses, I want to add one other thing on the minuses, because on the air conditioning stationary air, there is a knock-on effect from the SEER 13. As you know, there was a false economy created by SEER 13. And they pumped out -- so a lot of units got pumped out. A lot of that stationary air though, as Don mentioned -- again, when a unit goes bad now, an interesting phenomenon knock-on effect is that a lot of times people are not running out to buy the new SEER 13, although they produced a bunch of them to meet the new regulations. They may be, and what we're seeing is they're going to go repair what they have, their old SEER 10. So that's a negative impact as well. Just want to say it's -- some of it is new construction but some is really in the replacement, because you can repair your old SEER 10 at a lower cost than putting in the SEER 13.

But that's in the CIC segment, right?

Sorry?

That's in the CIC segment?

Yes, that's in the CIC segment. There's a knock-on in the light construction equipment that goes over to the other. In the markets that we're seeing -- absolutely there are some markets that are now doing better, if you will, than they were, and I think we've touched on them. But just again, the oil and gas, the mining, the power gen, these are --

Stronger in the quarter than they were in the quarter before.

Yes. Definitely any energy related is really doing quite well. That's why, again, and you saw into the Cabot, we did the Cabot Subsea acquisition Don mentioned. There's another one out there in the public that we're looking at and another -- that's energy related, and those are the -- those definitely are very hot markets right now.

And so what do we think about the -- my question about the extension into next quarter? Are we worried -- I mean, you're cautious because the HDT -- the heavy-duty truck comparison gets worse, so maybe you're not going to see any more improvement for a while, or you think you can overcome that? That's the question.

I would -- Go ahead, Pam.

All I can say is looking at the orders, I mean, the trend has been upward. So if that trend continues, because I have the individual months that I can look at which you don't have privy to, but I can just say that the trend has definitely been upward.

Very good. That's helpful. Thank you.

Thank you.

And the next question comes from the line of Andy Casey from Wachovia Securities. Please proceed.

Good morning, everybody.

Good morning, Andy.

First, I want to compliment Parker on both ability to deliver in the channel and then financially. First question -- Don, you talked about others framing market conditions as doom and gloom, and it's -- there's quite a separation when you look at both your orders and your base revenue growth in the industrial side. What do you think is causing that? Is it mix or is it share gains or what?

I'm sorry, this is Tim. I think that there's no question, Andy, that there are share gains, and I will -- again, I mean, there is plenty of evidence out there that a number of the people, our competitors, really have very very long lead times, having real difficulties delivering. And we've been able to maintain ours. And so there's no question. I'm not going to mention any names and so forth, but absolutely -- especially in certain parts of the world, over in Europe right now. People are scrambling for parts to build things. And so there are definite opportunities to take some market share.

Plus, Andy, we're highly focused on providing solutions to the customer that really save them money at the end of the day. We're really zeroed in on that. All of our people across the world are really focused on that. Where we're looking for solutions for the customer, that makes their life easier and saves them money. And when you really do that and you do it well, that's what happens.

Okay, thank you. And if -- just to remind me, if you could walk through the aerospace guidance, it still sounds like the first half should be dampened by the spares contract end and then the development costs you'd already touched on. So second half should reaccelerate. Is that about right, or?

Yes, that's right. And that's why the guidance is what it is. Okay, we're running out of time here. We have time for one more question.

And the next question comes from the line of Eli Lustgarten from Longbow Securities. Please proceed.

The last question, if I could.

Good morning, Eli.

Let me just clarify the aerospace comment. In order to make your guidance in aerospace, your second half margins have be in the 16.5 to 17% range. One, am I assuming correctly, and two, is there anything that would prevent those kind of numbers from being realized next fiscal year, as we look out to fiscal '09, that should be more the run rate that we see that year.

Eli, this is Don. It all depends on what kind of projects we're working on at the time. It's really influenced a lot by R&D investment spending and development work. So there are some major programs underway right now. As you know, the Airbus has a major project, both the A380 and the A350. There are several other ones that we're working on. So it really depends on when those development costs hit. But there's no reason to believe that anything bad is going to happen here in aerospace from a margin standpoint. If we have to invest a little more in future growth in the near term, we're going to get the payoff down the road. So we're still very positive about aerospace and the prospects both near-term and long-term.

Let me go back again -- I guess the international margin was so impressive at [16.7] that all of us are having trouble understanding why we're projecting under 15% for basically the rest of the year. Is there anything structurally that causes that other than maybe conservatism and volume, worry about volume -- is there any reason why margins should stay back in the 14 to 15% range for the rest of the year? Because that's what you have to do mathematically in order to be within your targeted range. Well, second quarter, I just want to remind you, and I know I might be focused on the detail, but second quarter is always our worst quarter. So I just want to make sure that -- But even with that, you dropped (inaudible) in the second quarter, but again you can't get much lift or anything. It'd have to be so dramatically different in the [16.7]. Is there anything structurally we're looking at that keeps the margins that much below --

No, don't read any of that into it.

Absolutely not, Eli. So if volume continues, then we could be looking forward to improving profitability there somewhat beyond what we're talking about.

Yes, we'll get another look at it in a couple of months here and be able to get a fresher look. And like I said, hopefully good things will be happening and we'll have some more good news for you.

Okay, at this time I would like to end the Q&A session, and I think that Don has some closing comments, and then we will end the call. Thank you so much for your attention.

Just a couple of comments. Well, needless to say, we did have a great start to the fiscal year. We finished a great year last fiscal. This quarter we produced -- obviously records in a lot of areas in sales and net income and earnings, and as a result we felt very comfortable when we talked about the increase in our guidance up to $5.05 to $5.35. So we're pretty excited about that. And it's happening in a time when not all of our markets, not all the regions are really doing all that well. So we've had very very good results in kind of a so-so environment out there. So we're pretty excited about that. I want to thank everybody on the call for your interest in Parker and for your time and for the questions. They've been very positive and we've enjoyed that and enjoyed having the dialogue with you.

The results, just to remind you once again that we're achieving, are a direct result of the execution of the win strategy. I know we've talked about it time and time again and that's where it's coming from. And just to keep in mind that it's not over. This strategy is going to go on, as far as I can see, forever. Because it's fundamental. It's how we've got to run this business. It's how we're going to have to win in the long run. So it's not something that we're going to be changing anytime soon. And hopefully we'll never change it. Our objective, as I've said in the past, is to maximize return on total capital, and that's what we're working hard on. We want our return on total capital in the top quartile of our peer group, and we've been in the top quartile here of late, and we want to maintain that position. I think just another thing to keep in mind is to note -- and we've talked about it a little bit -- is our organic growth rate has been over 3%, and even in spite of some of these weakening markets, or weaker market segments I should say, that's been pretty outstanding for us and we're very very pleased with that. And then lastly, I think keep an eye on the cash flows, and I think we mentioned that earlier. We've plenty of cash to reinvest and more growth for the company, and we intend to do that.

I also want to just take this opportunity on the call because I know some of our worldwide team is tuning in, so I want to thank the worldwide team of employees for their accomplishments. We couldn't have done it without them, and we want to thank them for that, and for continuing to properly grow our business year in and year out. So once again, thanks to everybody on the call for your participation. We certainly appreciate your interest in the company. Pam will be available the balance of the day to take some more calls. And just one last thing -- I have to get this in -- since I know we have a few Indians fans on the call somewhere out there, and I just want to say -- Go Tribe. So hopefully you'll be tuning in for the big game tonight. So have a nice day, and I'll turn it back over to Pam now.

Okay, thank you. As Don said, I'll be around this afternoon and look forward to talking to you. Thank you for your attention. Goodbye.

This concludes your presentation for today. Ladies and gentlemen, you may now disconnect. Have a wonderful week.