派克漢尼汾 (PH) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Q1 2009 Parker Hannifin Corporation earnings conference call. My name is Sandy, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's conference, Ms. Pam Huggins, Vice President and Treasurer. Please proceed.

Thank you, Sandy. Good morning, everyone. This is Pam Huggins speaking, as Sandy just mentioned. I would like to welcome you to Parker Hannifin's first quarter fiscal year 2009 earnings release teleconference. Joining me today is Chairman, President, and Chief Executive Officer Don Washkewicz; and Executive Vice President and Chief Financial Officer Tim Pistell.

Before getting into the Earnings Release, let me address a couple of administrative matters. First of all, for those of you that are online, you can follow today's presentation with the PowerPoint slides that have been presented, and for those of you not online, the slides will be posted on the Investor Relations portion of Parker's website at PHstocks.com. Second, as is customary, I would like to call your attention to slide number two which is the Safe Harbor disclosure on forward-looking statements and ask that you read this statement in its entirety. Third, moving to slide number three, this slide is required and indicates that in cases where non-GAAP numbers have been used, they've been reconciled to the appropriate GAAP numbers.

Now moving to slide four, the call will be in four parts today. First Don Washkewicz -- Chairman, President, and Chief Executive Officer -- will provide highlights for the quarter. Second, I'll provide a review including key performance measures of the quarter and of course concluding with a revised outlook for fiscal year 2009. The third part of the call will consist of our standard Q&A, and as a reminder please ask one question at a time. My goal is to keep this call to one hour, so please be courteous and get back into the queue if need be. And for the fourth part of the call today, Don will close with some final comments. At this time I'll turn it over to Don and ask that you refer to slide five titled First Quarter Highlights.

Thanks, Pam and good morning to everyone on the call this morning. Just wanted to make a few comments and then we'll turn it back over to Pam for a little bit more detail of the quarter results. First of all, I'd just like to say that we're extremely pleased today with the results that we delivered in the quarter. We posted record sales of $3.1 billion, which is an increase of 10% over last year's quarter. Particularly impressed and pleased with the organic growth which was strong at 4% in the quarter. Earnings and earnings per share for the first quarter were records for the company, so we've had a stream of records here for the last several years with earnings per diluted share increasing 13% to $1.50 a share and cash flow from operations was about 10% of sales or about $307 million.

Little bit about Aerospace, we delivered another strong quarter there with sales increasing at double-digit levels for the second consecutive quarter in Aerospace, and you're certainly all aware of the Boeing strike and that continues to impact our Aerospace business. That strike -- our shipments basically stopped in late September, about September 20th and of course as that strike continues on, that's going to continue to affect subsequent quarters going forward. You'll note that early in the first quarter, we announced another major long-term contract and that was with Bombardier. That was a $3.5 billion contract for development of fly by wire systems for them. And if you look over the last two years now, we have brought in about $10 billion in new business in Aerospace contracts over that last two-year period of time. So we're very excited about the long-term prospects of our Aerospace business.

This year, a little bit about acquisitions, we acquired four strategic acquisitions this year, which will contribute sales of $460 million. They're expected to be accretive to earnings. And so we're pretty much on target to hit that 5% of sales number we said that that was basically our internal target here, 5% of sales coming from acquisitions. That would imply that we'd have to do about $600 million a year at the current run rate of $12 billion for the company. So we're doing pretty well on that metric as well. And also during the quarter, we invested $414 million to repurchase Parker common shares during the first quarter and we announced a dividend increase for the 52nd consecutive year.

Just a couple comments on markets. I'm sure there will be more comments that we'll make later on, but -- and this was in the press release, the total orders are up 1% for the quarter versus a year ago. North America grew a modest 2%, while trends in Aerospace and CIC were stronger with increases of 9% and 5% respectively. Our Industrial International segment has continued to weaken and has been weakening now over the last several quarters. We've been watching that and reporting on that to you as that occurs. And right now the international segment had declined 4% in the recent quarter over the same quarter last year.

Distribution, being one of the strongest parts of our business, remains stable, which is about half of our industrial business and this continues to be a strength for us going forward. Some north American OEM markets continue to be weak. We've talked about these in the past. They're automotive, heavy duty truck, refrigeration, residential air conditioning, light construction equipment and semiconductor and so forth. Some of these major OEM segments have been really soft for quite some time now and eventually they will turn. But we're doing I'd say extremely well in light of the fact that many of these segments are down and have been down for quite a while.

Given this economic backdrop, especially in the latter part of our fiscal year, we decided to revise our fiscal 2009 earnings guidance downward by roughly 5% to a range of $5.35 to $5.75, as we have said in the past and will continue to do this in the future is we'll try to give you an annual guidance and we'll try to give you an update on that annual guidance on a quarterly basis. And that's what we're doing today. I think with everything that's happening in the environment out there today, it's really, really tough to predict what's going to be happening next calendar year, certainly. So we're doing our best here to give you the best guidance we have and of course this may ultimately prove to be conservative. But with the swiftly changing economy, I want to stress that like everyone else there's a higher level of uncertainty in the second half of our fiscal year. So we'll keep you updated as each quarter goes by.

The other thing I would like to say is just a little bit about the Win Strategy. Much of the work that we've completed under the Win Strategy over the past seven years was really designed to help the company perform better specifically in a downturn that we're experiencing right now. So for instance, today we have exposure to a greater number of end markets than we had in the past which mitigates our downside risk, and increases our presence in many less cyclical markets like energy, life sciences, biopharm and many others that we've entered into the last several years. We also have a much better geographic balance. Many of those on the call will remember the days when we used to have 70% of our industrial business in Industrial North America -- located in North America and now 50% of our industrial segment revenues are being generated from international markets. So that's a much, much better balance than we ever had in the past.

Our cost structure also is much more flexible than in the past and we continue to focus on certainly the lean enterprise activities that we've launched seven years ago, which will continue to help us through this period and other strategic initiatives that we've talked about in the past. So just keep in mind that the activities that are going on to prepare us for this period of time have really started seven years ago, and a lot of hard work and effort to get us to where we are now and that's the reason why we today are reporting record quarters yet. So as a result, Parker expects to perform at a much higher level throughout the downturn that than we had done in the prior period. So right now, I'm going to turn it back over to Pam and we'll talk more about these in a few minutes.

Thanks, Don. If you will reference slide six at this time, I'll address the earnings per share for the first quarter. You can see that it's $1.50 and this represents a 13% increase over the $1.33 in the first quarter last year.

Now, if you move to slide seven, I'm going to outline what happened in the first quarter. Earnings per share, this is on a consolidated basis versus the same quarter a year ago. You can see that a 10% increase in revenues, with double-digit increases in all segments, except CIC. Improved selling, general and administrative expenses as a percent of sales, declining to 10.9% from 11.7% as a result of lower compensation incentives, and lower outstanding shares as a result of $414 million in purchases this quarter in the open market. Offsetting some of these positive items were lower gross margin of 20 basis points, and this was due to a slight [link] in pricing as we discussed on the last quarterly call. Higher interest expense as a result of higher debt due to acquisitions, and of course the repurchase of the shares that I just mentioned. Higher other expense, and this is mainly due to an investment for tax purposes that was offset by a tax credit. And then of course higher taxes due to increased income, and then a higher tax rate in the quarter as a result of discrete benefits. However, you will see that the tax rate for the year has gone down from 30% to 29%.

So just to summarize these puts and takes for you in the first quarter, higher operating income contributed $0.14, lower corporate G&A expenses contributed $0.02. Lower other expense contributed $0.02, and of course less outstanding shares contributed $0.05. And these positive items were offset by additional interest expense of $0.02 and of course higher taxes of $0.04 that I just mentioned. Now, of course if you net all of these items, you can see that the $0.17 in higher earnings were of course quality earnings for the quarter, mostly coming from segment operating income and clearly a good performance in the quarter.

Moving to slide eight at this time and addressing sales, you can see that sales for the quarter increased 10% to $3.1 billion. This is up from $2.8 billion last year. And of this 10% sales growth, 4% is organic, 4% is the result of acquisitions, and 2% is the result of currency which is mainly the Euro.

Moving to slide nine, the 10% growth in the quarter, again, is the result of double-digit growth in all segments except CIC, and Aerospace led the way with a 9% organic growth in the quarter. Acquisitions added $125 million in the quarter.

Moving to slide 10, and focusing on segments, starting with North America, most notable on this slide is that in spite of several soft markets that Don mentioned, North American first quarter sales are up 10%. Of course, 8% of that is from acquisitions and 2% is core growth. So in spite of a challenging North American environment, operating income for this segment is ahead of last year at $160 million versus $155 million a year ago.

Moving to slide 11, now I'll address the industrial segment. Moving to international, here you can see that currency is becoming less of a contributor to sales, of course with the strengthening of the dollar, 4% for the quarter -- this is versus 15% last quarter. Organic growth was 4%, up against tough comparisons a year ago, however. Acquisitions added 3% and margins as a percent of sales remained at a high level at 16.6% versus 16.7% a year ago.

Moving to slide 12, addressing the Aerospace market segment, you can see that sales increased 12%. Margins increased 80 basis points, and this is mainly due to lower Research and Development costs than anticipated in connection with the new program wins in that first quarter.

Slide 13, climate industrial control segment. As mentioned previously, softness in North American automotive, heavy duty truck and residential air conditioning -- that's what's affecting this segment. That's what we've been talking about for several quarters. So as a result, sales are flat organically for the quarter and margins are flat year-over-year at 6.1%.

So at this time moving quickly to orders, orders for the quarter, slide 14. These numbers -- just as a reminder, these numbers represent a trailing three month average and are reported as a percentage increase of absolute dollars year-over-year, excluding acquisitions and currency except for Aerospace, and Aerospace is reported using a 12 month rolling average. As you can see from the slide, orders are up 1% for the September quarter just ended and this compares to 8% last quarter and 7% a year ago. North American orders for the quarter up 2% year-over-year, and last year at this time, orders were flat and this 2% compares to 4% sequentially from the June quarter. Industrial International orders declined 4% and this is up against a positive 19% last year. The negative 4% for this quarter compares to 8% last quarter and is partially due to a tougher comparison from June to September last year. Aerospace orders up 9% for the quarter which compares to 23% last quarter and 12% a year ago. And then in the climate and industrial control segment, orders are up 5% and this is up from a negative 7% last quarter and a negative 13% a year ago. This is partially due to easier comparisons and increased business in air conditioning.

So moving to the balance sheet quickly, you can see that Parker's balance sheet remains solid. Cash on the balance sheet at quarter-end was $608 million. $569 million in commercial paper was outstanding. Days sales and inventory increased to 67 days from 61 last quarter. And accounts receivable in terms of DSOs is 49, a 4 day improvement over last year. With respect to accounts payable, it was a use of cash but we do see some opportunity here.

Moving to slide 16, operating cash flow for the quarter was $307 million. And of this $307 million, $98 million or 3.2% of sales was used in connection with capital expenditures. Acquisitions consumed another $12 million. And just as a reminder, the three acquisitions that closed October 1st are obviously not included in these numbers. They'll be included in next quarter numbers. Dividends were paid in the amount of $41 million, and the remaining cash in combination with the issuance of commercial paper in the amount of $414 million was utilized to purchase shares in the open market. Moving to slide 17, you can see that the debt to total cap ratio is 35%. However, on a net basis it's 29%.

I'll now just give you the updated guidance, which is shown on slides 18 through 20. On slide 18, the guidance for sales and operating margin by segment have been provided. On slide 19, guidance has been provided for the items below segment operating income. And then of course on slide 20 the guidance is summarized on an earnings per share basis. As you can see from this slide, the guidance for fiscal year 2009 is projected to be $5.35 to $5.75 as Don mentioned. This assumes a 46% to 54% split first half versus second half respectively. And please remember that the forecast includes acquisitions that have closed and excludes any acquisitions that may be made in the remainder of fiscal year 2009. The revised guidance assumes the following -- sales growth approximating 0.8% to 1.2%, segment operating margins as a percent of sales in the range of 13.3% to 13.7%, corporate administration costs of approximately 1.5% of sales, and interest and other expense in the range of $175 million to $192 million. And of course the tax rate coming down from 30% to 29%. So at this time, we will begin our regular Q&A session.

Good day, ladies and gentlemen. (OPERATOR INSTRUCTIONS) Please stand by for your first question. Your first question comes from the line of Jeff Hammond of KeyBanc Capital Markets. Please proceed.

Good morning, Jeff.

Hi, good morning. Just wanted to get a little more color within the order rates in international, maybe just parse out where you've seen the greatest decline or maybe just give us a little more color, Europe versus Latin America versus Asia. And then within the international revenue guidance, can you just walk us through the moving pieces of Legris coming in, FX dynamic and how the base business has moved?

Okay. I'll start here. Let me give you a little bit of color on the orders, just to begin. First of all, just walking you through the quarter, which I think you had some interest in seeing how that played out, when you look at our orders, July came in pretty good. We had a fairly good sized dropoff in August. And when you get behind that dropoff in August, you find that it is in Europe and Asia both. What is happening there is some of the exports that are going out of Europe into Asia were slowing. We weren't alarmed at the time, because August is really a tough month for Parker Hannifin anyway. Everybody's on vacation over in Europe. We lose a lot of absorption in our factories and so August is one of those months, very difficult to see what's going to happen or play out in the rest of the quarter. So at that particular time, looking at it, we said okay, we'll wait and see how September comes out.

Well, September did come back. September was much stronger than August but of course it wasn't enough to make up for the August downfall. So we know that Asia had some play in that with the Olympics. We think that some of the exports going out of Europe weren't as strong. And we have said on the last call that we thought there would be some impact from Asia. So when you look at the regions around the world, you'll see that of course southern Europe is very weak. You look at Italy and Spain and that has been weak. I think it hit Parker later than what -- most people were talking about it earlier than Parker. Latin America continues to be very strong. Asia-Pacific, looking forward, we think that will continue to do well, even though it was very soft in August. Western Europe obviously you're seeing some slowing in some markets. You're seeing some slowing in Russia, for example. When you look at Europe at some of the markets that are slowing, truck for example, construction are just a couple, to name a couple.

Okay. And then if you could just hit on the moving pieces within the international revenue guidance.

Okay. You're talking about organically versus acquisition, that type of thing?

Yes, just acquisition FX and base business.

Okay. Let me just walk you through that a little bit. If you look out through the quarter, for fiscal year 2009, you can see that in the first quarter we had 11% in international growth. We had about 3% from acquisitions and we had about 4% from currency. Going into the second quarter -- well, let me address the halves. I think that might be a little easier for you, okay?

Okay.

First half international, 6% we're looking at -- 7% acquisitions and about 4% currency. So when you really look at the base business, you're looking at downturn of about 5%. In the second half, looking at international, we have a negative 5%, okay? We really don't have currency built into that for the third and fourth quarters. We have international down about 13% base business and about 8% coming from acquisitions. Does that help?

Yes, that's helpful. Thanks.

Next question comes from the line of Jamie Cook, please proceed.

Good morning, Jamie.

Hi. Good morning. Just a follow-up on the international business -- I guess my question is more around the margins. It seems like as we look out over the next year your base business in international is going to start to drop to the double-digit range, yet I'm surprised as I look at your margins in international they're still showing well above North America. Can you just walk me through your thoughts there?

Jamie, this is Tim. I would -- is guess one of the dynamics in international for us is we see -- international it's made up of a whole bunch of different pieces here and we have learned that in executing properly that we track some higher margins. So I think that the Latin America we'll say is very strong and running at a high rate, will continue to do so. Asia, likewise, is a good market for us and performing pretty well and we expect that to hold up pretty well. Europe, generally, now that we've gotten into this new territory and the way we've done it, we're hoping that we can preserve those a little more strongly going forward too. So it's really a mixed bag across the board, but Latin America and Asia as we've said for years have always been good for us and higher margin and they remain the stronger. We see the fade in Europe, but we think we'll hold up pretty well.

Jamie, there is one other point that I would make is that the weakness that we're seeing in some of the -- in the regions are from the OEM side of our business which tend to be the lower margin side of the business, and distribution as I mentioned earlier is still pretty solid out there, really worldwide. And we've worked hard over the last seven years, building that aftermarket and that's a higher margin business for us. So I think when you look at the mix, with the mix changing, that's going to have an impact as well.

Okay. That makes a lot of sense. Thanks, Don and I'll get back in queue.

Thanks, Jamie.

Your next question comes from the line of Nigel Coe of Deutsche Bank. Please proceed.

Hi, good morning, Nigel.

This is actually Nicole asking questions for Nigel, how are you?

Hi, Nicole, how are you?

Good, thanks. Just one for you on industrial. Piggybacking on Jamie's question. Could you just go through all the end market trends you're seeing there, both in North America and internationally?

You're talking about in end markets?

Yes.

Okay. If you look at North America, distribution is obviously still positive for us. And our industrial business is positive for us. And specifically within the industrial business, machine tools is hanging in there. Mining is hanging in there. Well, it's more than hanging in there in North America, to be honest with you. General industrial is doing well. Telecom and oil and gas. When you get into the mobile side of the business, believe it or not off highway construction is still doing better year-over-year. Farm and ag, our lawn and turf business is doing well. And then of course forestry.

Now, when you move to Europe, okay, distribution again still doing well. Total industrial's doing well. The machine tools is hanging in there. Mining's hanging in there. General industrial, power gen, of course oil and gas, cars and light trucks still is up for us year-over-year and again farm and ag and marine. And you get to Asia-Pacific, just to walk you around the globe here a little bit, distribution is good. Total industrial is up there, and the mobile business continues to be up. Farm and ag is strong, and of course industrial trucks and material handling. Then you get to Latin America and almost everything is up for us still.

Okay. Great. Thank you.

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

Good morning. Let me say, Pam, I find your guidance for this year really stunning. Considering --

My guidance?

Stunning, yes, because economists in all stripes are now forecasting a very deep and long recession in the US. I just published a report where I'm talking my assumption, 1% to 2% decline in GDP in the US and who knows what outside the US, and yet you've only reduced your guidance by $0.30 for this year. And if we assume that there's another $0.30 for the second half of calendar 2009, that $0.60 decline is only 10%. Now, in the last recession I think you were off 50%. So I know you've explained something about why this is, but I'd like to know what your forecast assumptions are in terms of the US economy for 2009 and also for the world economy and the various parts of it -- what's built into your numbers? Are you taking the really terrible economic outlook fully into consideration? And the second thing is, because you said some slowing in Europe, I mean, it's not slowing, it's going down. And thirdly, I mean, I'm talking the economy in Europe. Is there share gain going on here? Is that one of the reasons for this very small decline in your guidance, market share gains? Can you address that issue also?

This is Tim. Let me try to answer I think a fair question. Frankly, we have obviously guided down here today. We've lowered -- we have very good visibility into the next quarter, which takes us out through December. We do not have that great of visibility, frankly, beyond that. And I don't think any of us -- truly anyone that I know of knows exactly what the world's going to be like here, come next spring and next summer. So we have taken things down a little bit, again, reflecting what we've seen to date. We did decrease the second quarter. We slightly decreased the third and fourth quarter. But as Don I think said earlier, we will update this as we go. We really do not know. I don't think anyone really knows what's going to be going on in the world come next spring and next summer, although we all know credit's going to be extremely tight and that's going to hurt and we'll have to deal with it. So we were -- that's what we've done and that's what we've reflected here. We don't pretend to be experts and know, frankly, what it will be like next calendar year. We toned it down some. It could prove to be conservative. It also could prove to be very optimistic. But we've done the best we can.

Now, let me also address what's different at Parker because during the last recession, we had no downturn on our top line. We grew on our top line all the way through the recession, primarily driven by acquisitions. We've just done another three big acquisitions beginning of this quarter who are all great franchises and added those to the family. The falloff that you were addressing, which is very valid, and that -- so was not on the top line, it was on the margin line, the income line. And we've learned from that lesson, we hope, and we have done a lot of things we think in terms of diversification and also lean enterprise that we will manage much, much better through any kind of a decrease. We don't think the drop will be nearly as bad in our base markets, and we also feel that we're much better positioned to manage through that decrease and maintain the margins. But frankly, good visibility through December. After that, Alex, we really don't know. And I would say anyone else probably -- I don't know anyone who knows.

An honest answer. But what about the share gain I asked about?

Share gain, I will tell you something, that's -- up until a few months ago, there was some great opportunities. We all had too much business. If people could not deliver, they were losing and other people were gaining and I think there was a lot of that. Alex, I now think we're in an environment where as business drops down, everyone is going to get caught up on their past dues, they're going to fight like crazy, very difficult to take any shares at this period.

Okay. Thank you.

Right.

Thanks, Alex.

And your next question comes from the line of Henry Kirn. Please proceed.

Good morning, Henry.

Good morning, guys. You've mentioned distribution being strong globally a couple times. Just wondering if you could talk about inventory levels at the distributors and how you see those and how much visibility you have there?

This is Don. We really don't measure our distributors' inventory at all. We don't ask them about their inventory. We don't go surveying their inventory. I can just tell you that as the company has become more and more lean and as our delivery performance has continued to improve over the years that our distributors adjust their inventory based on how we respond to their orders. So I could tell you that over time, generally speaking, the distributors' inventory probably has been coming down over time on a relative basis because we have been doing a better job at delivering on a just in time basis to them and getting them the product they need when they need it. So that's -- I would not say that we have any big build-up in inventory in the system that has to be worked up anywhere that I know of. And I would say that I'm speaking pretty much globally about that -- the distributor organization out there.

And if they were to choose to destock, how quickly could you respond to that?

If they choose to destock?

Right. If they choose to run with even lower inventory level than they have today.

What you really have to remember is that on any particular product, I can't answer for all the products because we have [a million] of them, so -- but on any particular product we can respond at varying rates to restock the distributors. We deliver right now at about a 90% level line items shipped to request date. So at about a 90% level. That number is gradually going up. We used to measure parts shipped on time. We've changed it to line items because we think that's more in tune with what our customers are measuring and so as we focus on that, we are responding to the distributors on a real time basis to their needs, as they need it.

Don, if I could. Henry, this is Tim Pistell. Excellent question, though, because in years gone by, when slowdowns would occur, we would have stockpiles of inventory in our plants and so would the customers and so would the distributors. And it was a real problem when a slowdown occurred because you you had to work through all that inventory before you could start producing again. I will tell you when we go out and we visited, as Don said, we visited our distributors, visit our customers -- they do not carry inventory. They're 100% dependent on us to ship what they want, when they want it. There is no inventory out there, very little, and we do not have much in our plants either. When things slow, we feel it instantaneously and that hurts. But we don't have the old problem and when things will turn around, they'll come right through and it will benefit us when that happens.

Okay. Thanks a bunch.

Thanks, Henry.

And your next question comes from the line of Mark Koznarek. Please proceed.

Good morning, Mark.

Can you guys hear me?

We can.

Okay. Great, good morning. I have a question about the international margin outlook, because if I understand the answer to Jeff's question a little bit earlier about what the core growth is for international, it seems like it's now down 8%. And at the beginning of the fiscal year you thought core growth in international would be up 4%. So pretty big swing. However, the margin expectations were 15.8% at the midpoint and now it's 15.2% at the midpoint. It's pretty striking. It seems like the core revenues from the international segment will be off $600 million, and you guys in the past have talked about a detrimental margin of 30% and that is getting close to $200 million of lost operating income. So I'm surprised that you'll be able to maintain the margins still in the 15% range, and I'm wondering if you can talk about how you intend to do that. Is there aggressive cost reduction that you've now put in place that was not contemplated 90 days ago, or what's really going to hold the margin up so substantially?

Well, Mark, one thing I think that people have to remember is the composition of our business is much different in international than it's ever been before. We did -- two years ago we did over $1 billion in business, so when you look at that $1 billion of business, most of it was in Europe and it was in businesses that had good margins that don't have the cyclicality that some of our other business had. So a lot of it revolves around that. I mean, the composition of the business is really different. It's going to give us pretty good margins over there. And we do have -- I mean, we are still very much focused on the Win initiatives. We're very much focused on our lean. We're very much focused on our strategic procurement and -- so we do have cost initiatives that we're working on every day with people all around the world.

Well, I'm asking specifically is there anything new that you've implemented in the last 90 days with regard to cost?

No. Mark, is this is Don. The message to the organization is pretty clear. That is -- through this period that we're going through, we don't want to see inventory -- we don't want to see inventories drastically going up and we don't want to see productivity going down. And so the message is you better be real time as far as adjusting to market demands. And if we are real-time adjusting to market demands, we'll avoid a lot of the runup and rundown crises that we go through in a typical upturn and a downturn in the economy. So that's really the message. Of course, the obvious things we're doing everywhere around the world as far as discretionary expenditures and costs like that, I mean, these are just routine that we're cutting back wherever we can in those areas. But more importantly, we're very much focused on maintaining discipline with respect to productivity metrics through this period of time and making the proper adjustments real-time, so we're not pushing out actions that we need to take right now.

I guess one other thing that's different from 90 days ago in international is the Legris and Origa acquisitions and that's now in your new guidance and it wasn't before. Are those margins substantially above 15%? Is that part of what's different now is the mix of -- ?

I would say those margins are comparable to the rest of our margins in Europe.

Okay. All right. Good. That's helpful. Thank you.

Thanks, Mark.

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

Good morning.

Good morning, Eli.

Let me -- I have a little bit of a complicated question. If I heard you correctly during the conference call, you said the earnings split would be 46% to 54%, first half, second half. Therefore the implication on your guidance is the second quarter will be something in the vicinity of $1.05 to $1.10. Can you carry us through how we get that big change? How much of it is the adjustments to the new environment internally? And if you can also talk about the tax rate going down 29% -- I assume the R&D tax credit is helping. Is its going to be a one time adjustment? Is that still helping the second quarter more than the other quarters? Is there an Aerospace catchup in the second quarter, given that you're well above margins of [14.2%] in the first quarter and bigger volume -- and in a year you're talking 13% operating margins and much lower volume [gains]?

Eli, this is Tim. We have built in -- first of all, it's general market downturn for the second quarter, I mean, the second quarter always is a drop from the first quarter for us. But we have gone ahead and built in a market downturn, and that is the preponderance of it and we carried that through to the third and fourth quarter. Additionally, in the second quarter, we have the Boeing strike and some costs related around that too, which -- Boeing and Aerospace related, it will be a hit in the second quarter. And we also have -- I'm sorry?

Are you going to quantify that at all, what magnitude that might be?

$0.03.

$0.03 on that.

Okay.

Okay? And the general market downturn, I tell you, is around $0.20 a hit in the quarter and we built that in for the next couple of quarters. Just as I say, general malaise in the market. Is that enough? Alex is challenging, and rightfully so. We don't know. But it's what we see to date, so it's what we put in and it's what we carried forward. So the Boeing and the Aerospace related is $0.03. We also have a restructuring that is going to occur in one of the segments and I'm not sure, Pam, how much of that's in the public domain as to where that restructuring is going to occur. I don't think it has. So I can't really get into that. But that's another $0.05. All right. And then we do end up with a gain. We do have a pickup on the tax rate and we have a pickup on the -- having done the share repurchase and that should be worth about $0.10 a quarter for us positive. And then there's some other miscellaneous items -- that's about $0.05 in the second quarter.

Okay.

Against us.

And I guess basically your implication is that the third and fourth quarter bounces back, basically around near the first quarter level, I mean, is that -- ?

Yes, it does. Which by the way would be disappointing, I mean, compared to years gone by. Certainly, Eli, you would expect our third and fourth quarter to be better than the first quarter and on a normal type economy environment it would be. So that's what we have. But again, as I told Alex, frankly, we don't know. We think we're going to -- we'll know a lot more a few months from now, after the election in the United States and after these markets settle down and everything else -- we'll be a lot smarter a few months from now.

Eli, this is Don. One other thing to remember is that we did not put in a continuation of the Boeing strike, any impact of that in the third and fourth quarters. So if that were to continue, we're talking maybe $0.04 negative for each of those quarters in the third and fourth, but we do not have that in this guidance as you're seeing it today. We do have some in the second quarter. We're hopeful that they'll be able to get this resolved. Already it's run longer than they've had in the past -- they've had these issues in the past. Hopefully we'll be able to get this resolved in this second quarter. If we don't, remember that we'll be -- this guidance will be high by about $0.04 a quarter going out.

Thank you.

Thanks, Eli.

And your next question comes from the line of Ann Duignan of JPMorgan. Please proceed.

Hi, guys. Good morning.

Hi, Ann.

Could we talk a little bit about your outlook for the integration of your recent acquisitions in terms of both on the P&L and on the balance sheet? And the cash flows?

Ann, this is Tim. I would love to talk about that outlook because we've rolled out a whole -- I think we've always been extremely good acquirers for a decade, and I think we've done a decent job on integration. But I think there were occasions where things would slip through the cracks. We've now introduced a whole new process and some software and some new discipline and we're very excited about it. We in both -- all three, we actually did three, Legris and Origa overseas and Hargraves here -- I mean, we had people there on day one, welcome them, introduced everything to them. We have integration managers in place. Our goal is not to lose a customer, not to lose a key employee, and make it as smooth as possible and it's really beginning to work. We've run it, and it's really wonderful. I'm very encouraged. We think that's gone very well so far. People are extremely happy to be part of the family. They now know that they're part of a big strategic package and all in all, we're very, very encouraged.

Could you be more specific -- how much did you pay for the recent acquisitions? What kind of inventory write-up will you be looking at over the next couple of quarters? When would you expect the recent acquisitions to be accretive? Just a little bit more granularity.

We expect them to be accretive right away. These overall -- margins were all very good in all three of these. These were not fixer-uppers, they were all successful, good businesses. In terms of getting the actual entries done, the purchase accounting takes anywhere from three to six months, and we don't have that finalized yet. We do expect them to be accretive within the year, and I'm sure by later in the year we'll be able to tell you how much they gave us.

How much did you pay for them?

I don't know if we have that information out. We have not disclosed that information.

Would it be from a modeling standpoint we should assume it's not much different from historical?

I would -- not much different although multiples have come down slightly, so I would -- multiples a little lower than what you've been used to seeing but still decent multiples. They were good companies.

Okay. And on the interest expense side, you took up your interest expense on the back of these acquisitions, but can you just talk a little bit about is there -- did you have to pay more in terms of -- for your debt or are your distributors finding any problems on the financing side out there?

Well, that's two extremes. So let me deal with your -- let me try to deal with both of them. In terms of these acquisitions, we did most of these on commercial paper, whether A or A1/P1, we have had no liquidity issues. We have done very well in terms of acquiring Euros necessary to do the two big deals in Europe. Right now, it's all sitting out there. It's commercial paper and it's at a level that is within our range of how we like our debt portfolio to look. So the commercial paper for us had been running anywhere in the 220 to 240 basis points range and as I say, we're not having any issues with that. If there's an opportunity to term some of that out later, we'll look for it. We'll take it. But we're very comfortable where we are. So that's that bit. In terms of our distributors, we -- at this point in time, we're not hearing any issues. Most of our distributors frankly are very successful business people. And we really rarely, rarely see an issue with a distributor, even when they go through downturns because they -- we work with them hard to be good financial managers and they're in pretty good shape.

Okay. Thank you. I'll get back in line.

Thanks, Ann.

And your next question comes from the line of Joel Tiss of Buckingham Research. Please proceed.

Good morning. How's it going?

Good morning, Joel, how are you?

All right. I'll just glue two together to make it quick. Can you talk anything you're hearing from your operating managers, real-time, what's happening to the pricing conversations -- how much resistance you're getting or price increasing still going through? And then also maybe a little philosophical. Don, how do you feel about going into what could be a more difficult environment for the next couple years and your debt's already 35%. Are you going to stick to your 37% target or do you see enough opportunities at realistic prices to go higher? That's the two. Thank you.

Those are good questions, Joel. Just a little bit about the pricing. Most of the pricing activity now for this year is behind us. We're pretty much caught up. I'd say probably 99% caught up on price increases that we've rolled out this year. As I've said in the past, we have either an increase in the aftermarket part of our business, either once or twice a year, depending on our requirements. That goes on pretty routinely. And on the OEM side, we're negotiating those on -- typically on an annual basis because typically these are annual contracts that we're dealing with.

I would want to point out that as far as raw materials, we see good things happening from the standpoint of raw materials where the escalations that we've seen in the past, which have necessitated big increases and pretty troublesome increases, frankly, when you looked at what happened in the last several months on steel, for instance, where we had one increase, one month. We went out, tried to recoup that and then four weeks later we get another increase and we're out of a magnitude that we had to go out again. That is behind us. We don't see that now. Actually, there's a lot of pressure on raw materials. I think we're going to see a lot of softening there over time and flattening out of these -- this inflation from a raw materials standpoint.

I feel comfortable with our debt levels. We have a 37% target and we're comfortably within that right now. We're generating wonderful operating earnings in the company and I think that number's going to continue to drift down over time here. We're certainly disciplined about the acquisition activity. We made several here. We told you that we would. We told you that we wanted to grow 5% from acquisitions. We'll do that and we're generating the cash to be able to do that and so I don't see any real issues there. Of course we're going to be prudent going forward. We're going to be monitoring the environmental conditions out there and making sure that we're not getting ahead of ourself, but we feel comfortable with what we've done so far. We think we've taken the right actions. We brought on some tremendous businesses here. As a matter of fact one of these we've been talking with for probably 25 years. So the fact that we're able to bring some of these on board is a tremendous success for the company.

So no, I feel pretty positive going forward and I think that -- I don't think we're going to have a need, hopefully, to really be pushing a lot of price increases through. Not in this environment. I think everyone is going to pretty much hold the line here. I don't think you're going to see demand in the near term anywhere near what it was just a few months back. And if you could tell me what the oil price is going to be, I'd give you a little more color on what we think might happen. When oil goes from $150 one week down to $88 the next week, boy, I tell you, it is a roller coaster ride we've never seen before. But I think that basically characterizes my feelings about what we see coming.

Okay. Thank you.

Sure.

Thanks, Joel.

And your next question comes from the line of Terry Darling of Goldman Sachs. Please proceed.

Good morning, Terry.

Hey, Pam. Wondering if you could give us the organic acquisition and FX breakouts for the other segment -- Aerospace, CIC, and international North America, as you did on the Industrial International?

Boy, you want a lot from me, don't you?

We're having fun today. Let's keep it going.

You want all of them, North America?

Save yourself a lot of time with the after calls here too, right?

Okay. North America, let's start there. We had first quarter as you well know, 10% forecasted, of which 8% was acquisition, really no currency and then 2% organic. Going into second quarter, North America is 7%. Acquisitions are about 9% and then of course organic is minus 2%. Again, let me give you first half and second half. I think that's easier.

Okay.

North America, 8%. Total 8% acquisitions, 0% currency and of course flat organic growth. Going into the second half, total minus 3% -- 5% acquisition and minus 8% organic. Okay. Moving to Aerospace, 6% total for the first half -- 2% acquisition, really no currency and about 4% organic. Going to the second half for Aerospace, it's relatively flat. No acquisitions or currency and so it's flat organic. Moving to climate industrial controls, first half -- total negative 2%, no acquisitions, just no currency to speak of. It's really a rounding. And then negative 2% organic. Going to the second half for climate -- minus 4% in total, again, no acquisitions or currency and negative 4% organic.

Okay.

Does that help?

Yes, that's great. Is there a headcount number across the company you can give us today versus last quarter?

It didn't change a whole lot. It's about the same. 61,000.

Okay. And then I guess lastly, wondering if you can help us understand the Boeing strike assumptions. I think you mentioned $0.03 next quarter. Can you help us with cost versus revenue? Revenue goes to zero. Are you scaling cost down as well or is it -- that's the full effect of the underabsorption. There's nothing you can do to flex the cost on a temporary basis?

It's the latter.

We had this discussion in past quarters where you're spending a lot on R&D for these programs. We're now getting a number of the financing agencies in the airline industry signaling to Boeing and Airbus that hey, guys, it might be a good idea for you to scale back production. If we were just to assume that Boeing and Airbus -- the strike ends for Boeing, but production cuts in the second half '09 and then in 2010 to where production is down in 2010 versus '09 -- how do you reconcile that situation that you've spent a lot of money here? Is it just that the math over the 30 year life of the program, you're going to take a little bit of hit on return of the life of the program and it's a little bit of backend loaded and there's not much you can do there or is there something else you can do there?

That's a good question. This is Don, and maybe that's a good lead in on clarification of some things I said earlier. The one thing we will not do in this downturn is we're not going to cut Research and Development. We're not going to cut engineering talent in this organization. If anything, we're going to be putting more and more emphasis on innovation. We've launched that initiative several years ago. We have wonderful things coming through the pipeline and I will not allow that. We're building for the future, building for the long-term here, so I'm not going to allow that to be cut. I've already made that very clear to everyone in this organization. So just to make that clear because even though we're talking about productivity and other metrics that we're going to be monitoring here very closely, when it comes to our engineering talent and our innovation investments, they're going to go on as they have in the past.

Now, more specifically to Aerospace and your question, those things happen. I mean, we get sometimes in these situations where we have a lot of sunk cost here, as far as Research and Development we've spent $30 million the last seven years. We're adding to that this year as far as these new programs. As I mentioned earlier, we have about $10 billion in new programs now. It's not the kind of thing that you can start and then shut off. We have to complete those development programs, and I think you answered your own question a little bit when you say that it's a pushout effect and that's exactly what happens. If they don't make as many planes this year or next year, we're just going to have to wait a couple or years for the payback and the payback is going to be basically in the aftermarket and MRO part of that business. As you know, we don't have a great margin on OEM side of that business to begin with. So it's a matter of when those planes get into service and how much aftermarket activity we generate from that -- the fleet that's out there.

So we will not slow down. We're going to stay focused. Of course, if a customer cancels the program of course we'd cancel any additional investment on development. But by and large, all of these programs as far as I know right now are going forward, not only on the commercial side of the business, but also on the military side, the business aircraft side, and the regional aircraft side. There's a tremendous number of new programs going forward and I haven't heard of any cancellations. So hopefully that answers your question. It's really a push-out effect. We'll just have to wait a little bit longer. Nevertheless it will have been a good investment.

Thanks very much.

Thanks, Terry.

And your next question comes from the line of Daniel Dowd. Please proceed.

Good morning.

Good morning, Dan.

Can you comment on how important the build-out of the Parker stores is to your guidance here for Industrial North America and Industrial International?

This is Don. I would say that it's not important in a total sense, a quantitative sense. Of course, over a period of time the impact of the stores is going to have more and more impact on this company. As you know, we have a goal of adding one distributor location a day. It's like a McDonald's franchise if you want to look at it that way. Somewhere in the world, we're adding one distributor location a day. That's been going on for quite a few years. And I'm pleased to say that we have a very, very strong network now and it's getting stronger every day and these by and large, the majority, I'd say 98% to 99% are profitable and they turn profitable very quickly.

So those stores and the distributor business, part of our business, which should not be underestimated by anyone on the call, is the strength of this company. It's the strength from a margin standpoint -- and what we're doing out there is we are servicing the hundreds and hundreds and hundreds of billions of dollars of installed equipment that's out there running every day that needs to have replacement parts, needs to have Parker service and parts on a daily basis. So to the extent that we can be close to the customer -- he who is close to the customer is going to get the business, typically. And that's our strategy, very simply put, is we are going to be everywhere and we're going to be located close to the customer, everywhere around the world, and capture as much of that installed base that we possibly can. And that number will increase over time.

So that's the strategy. We've been rolling it out. Obviously some of the impact that you're seeing today is a result of as I mentioned before, the seven years of roll-out of the Win Strategy -- and by the way the store concept and the distribution strategy is explicit right on the Win Strategy. This is all part of it. And we just haven't talked a lot about it, but we'll be talking more as time goes on.

You mention previously that neither you nor your distributors were having problems in the debt markets. Have you seen anything with your suppliers, because it seems in some ways that may be the bigger risk to near-term earnings?

This is Don again. Personally, I have not heard anything with respect to our suppliers or our distributors. Keep in mind, in the last downturn, which was a very long downturn for us, it started in October of 2000 and went three years. That was a pretty tough period for us. I did not recall anyone that was having issues with respect to capital. Of course, everybody was playing it pretty tight back then but we maintain -- as a matter of fact, I can't think of one distributor that went out of business through that time period, of the thousands that we have. So -- and on the supply side, I have not heard anything. I'm going to let Pam and Tim weigh in if they've heard anything. But I have not personally heard anything from a supply side that they're having issues right now.

Just very quickly. As part of our overall risk management program, working through the VP of Procurement, we monitor all those key suppliers and make sure that their balance sheets are healthy -- they're in good shape. We have not had any issues, no.

Sandy, at this time we'll take one more question and this will be our last question, please. Thank you, Dan.

Thank you.

Your last question comes from the line of Robert McCarthy of Robert W. Baird. Please proceed.

Good morning, everybody. Thanks for taking another question.

Good morning.

Can you you talk a little bit -- I'm not sure who to address the question to. Maybe Tim. Could you talk a little bit about how you're thinking about share repurchases? You were very active in the quarter. Stock of course has come in significantly since then. Understand that short-term outlook is difficult. You've pushed financial leverage -- the high end of your comfort range. I assume a little bit higher given the deals that you did at the outset of the quarter. So, do you feel constrained by balance sheet or could we see you continue to be active in a meaningful level?

Well, Rob, really, our outlook and our approach doesn't change now than any other time. Frankly, we're trying to generate at least 10% cash from operating activities, 10% of sales, which we did attain this quarter. So we're trying to do that. We're going to take care of that dividend, 52 years of increasing it. We'll take care of that. And we are going to look at any opportunities to grow the company, be it internal, which can be CapEx requirements or acquisitions. Always hanging out there to the side, though, is the opportunity for share repurchase and we look at that and try to maintain some discipline between it all. So those are our choices. We still have a little bit of capacity left and anything is possible.

I will tell you, frankly, that we are positioning the company right now for the upturn. And I make this real clear. We positioned the company for the downturn starting as we said, six to seven years ago with the Win Strategy and the lean enterprise. And more intensely even two or three years ago when we really started getting into cyclicality. So we did all of the hard work in terms of the downturn several years ago, and we think it's coming through now and we're feeling pretty good about that. Frankly, right now we are actually in a mode of positioning the company for the next upturn and part of that will be -- how do we use our capacity? So we still have some left. We will generate quite a bit as each month ticks by and then we just look at the alternatives. What are the growth alternatives and what is the share repurchase? And I can't really -- I won't make any commitments to either, but that's what we're doing right now.

So underlying point then is that the current environment and current -- including the current credit environment has not really affected the way you're thinking about this over the next 90 days, say.

Not at all. And it just -- we feel very, very good about all the actions we took. We used the accordion on our credit line over 1.5 years ago. We've added more banks in. We've got a lot of healthy relationships. We strategically couldn't be in better shape. And so right now it is a good time though probably to accumulate some dry powder and see what opportunities come around.

If I could then follow up -- I just had one follow-up to the commentary before about your outlook for the Aerospace segment. Full year outlook, you've taken down by about $20 million of revenue, maybe $2.5 million of operating income, and you've identified an impact of the Boeing strike in the second quarter. So am I to infer from this that this small reduction in the full year outlook is in effect the second quarter impact, and will -- your expectation is that you will not make it up? Or do you expect to make it up and is this a small adjustment with the expectation that your commercial aftermarket business would soften up some with weaker economic conditions, which I think has been your historical experience?

No, Rob, this is Pam speaking. What you're seeing in the guidance is exactly what you said, it's the second quarter impact. I think we feel that will not be made up and I think Boeing -- which is the biggest portion of that -- is the same way.

Okay, so then if the rest of your outlook is on a net-net basis, unchanged, within that have you lowered your expectations for the commercial aftermarket with some positive offset from some other piece of the business or is that a source of risk?

Well, what happened in the first quarter is really we didn't see the impact from the commercial aftermarket. We didn't see the decline that we thought that we would see to some extent.

Okay.

But we still expect that to come fast and furious. We gave you guidance before that already projected a decline in the commercial aftermarket, was already built into the guidance and we think that will continue.

Okay, very good. Thanks.

Thank you. At this time, I just want to thank everyone for attending our teleconference today. Thank you very much and we will conclude with Don. Don has just a few closing comments. But again, thank you for attending today.

Thanks, Pam. Just a few, just quick comments here. Again, we're very pleased that we're able to deliver a record quarter to start off this new fiscal year. And as we talked about on the call, we -- the outlook is really uncertain for the second half. We're giving our best look that we have right now but the one thing I can assure you of is that we expect to perform much better in this down cycle than we've ever done before. We remain focused on growing the company. Profitable growth is really the focus for the long run. Our work as we mentioned earlier to prepare for this economic slowdown, as Tim indicated earlier, began seven years ago when we launched the execution of the Win Strategy.

So we're in a much, much better position today -- actually it's going to be fun for me to not have to answer what happened in 2002 going out here. So hopefully, some of those data points are going to fall off your charts. We're going to have some nice data points to be looking at here. We expect to do a lot better this go around no matter what hits us than we've ever been in the past.

Lastly, I would just like to -- since many are listening in -- on behalf of the leadership team, I would like to thank Parker's worldwide team of employees for the great results this quarter. And certainly for all the positive changes in Parker that they have driven over the last seven years. We know that they're going to be working hard through this period to deliver better and better results this go-round. And I want to thank them upfront for all their hard work and effort.

Lastly, just thank you, the people on the call. I know you're going through a lot of tough times right now too in your own organizations. We want to wish you the best. We want to thank you for your participation on this call and certainly appreciate your interest in Parker. Make sure you stay in touch with us. We want to know how each one of are you doing for sure. If you have additional questions, feel free to call Pam. She'll be around the rest of the day. I'm sure there will be a few questions that still have to be answered out there. Once again, good-bye and have a great day.

Thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Good day.