派克漢尼汾 (PH) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Parker Hannifin Corporation fourth quarter and fiscal year 2009 earnings conference call. My name is Michelle, and I will be your coordinator for today. At this time, all participants are in listen only mode. We will be facilitating a question and answer session towards the end of today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

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

Thanks, Michelle. Good morning everyone. This is Pam Huggins speaking, just as Michelle said. I'd like to welcome you to Parker Hannifin's fourth quarter and 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.

As usual just let me address a couple of administrative matters prior to beginning with the actual earnings release. For those of you online, you may follow today's presentation with PowerPoint slides that have been presented and for those of you not online the slides will be posted on the IR portion of Parker's website at PHStock.com. Second as is customary I'd like t call your attention to slide two which is the Safe Harbor disclosure on forward-looking statements and ask that if you already done so please take note of this statement in its entirety.

Third moving to slide 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. Moving to the agenda, on 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, and second I'll provide a review including key performance measures of the quarter and year and concluding with the outlook for fiscal year 2010. The third part of the call will consist of the standard Q&A session and 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 "Fourth Quarter and Year-to-date Highlights."

Thank you, Pam and welcome to everyone on the call. I want to start with a few comments for the year. I'm going to be focusing on a year not so much on the quarter at this point.

Despite a record first quarter, the global recession hit hard in the third and fourth quarters. Earlier in the year as we saw the early signs of a recession imminent, we established a go forward strategy I want to kind of go over that with you. Our goals were as follows: First of all was the manage for cash, not ROS. We knew that making the right decisions would have a negative impact on ROS. For instance, inventory reductions, reductions of force, restructuring and so forth, but we decided that was the best thing to do for the company. We aggressively wanted to manage inventory and working capital. We targeted a 30% MROS, excluding reductions in force, inventory reductions, and acquisitions, and I'll give you an update on that in a few moments, and we wanted to cancel or put on the back burner, if you will, all major capital projects that we had in the works.

As a result of those efforts, we generated $1.1 billion in operating cash flow or 11% of sales, and we're certainly very pleased with that performance on a cash flow basis. Cash flow is particularly strong in the fourth quarter, as we generated $413 million in operating cash, or a record 19% of sales. For the year, we reduced inventory $240 million and of course, everyone realizes I'm sure that that's very difficult to do when you have orders going down, cutting inventories is very very difficult and does impact the operating results of the company. Our intention is to continue using free cash flow to pay down debt, and in the fourth quarter, we further reduced outstanding debt levels by $311 million bringing our debt to total cap ratio to 35% at year-end.

These actions are helping us maintain our strong credit ratings. I'm also pleased that we were able to generate segment operating margins approaching 10% which was our goal for the year, and our marginal return on sales for the year was on target as well. Parker employees throughout the world have responded extremely well and their efforts were instrumental in delivering a number of performance highlights for the year and for the fourth quarter.

Looking at the year ahead, and based upon current order rates, which are down 38% and those were in the news release, we do not anticipate any near term changes in our markets for this calendar year. We believe unemployment levels will be the key indicator of an economic recovery, and we will get more bullish when unemployment levels start to show improvement, and reflecting these conditions and the trends in our business, we are initiating guidance for the fiscal 2010 year in the range of $1.25 to $1.75 per diluted share. This range is consistent with our ongoing MROS target on sales.

So with that we'll go ahead and turn it back over to Pam and give you a little bit more detail.

Thanks, Don. I'll start with more detail on the quarter.

Please refer to slide six starting with the earnings per share for the quarter. Earnings per share of $0.31 for the quarter compares to earnings per share of $1.47 for the same quarter a year ago. Included in this $0.31, however, is a gain. Inventory gains from LIFO of $0.09, and this is classified in other, below segment operating margin, for reporting purposes. Also included in the $0.31 is $81 million in inventory reductions during the quarter, and $0.07 in realignment charges for the quarter. The $0.31 earnings per share exceeds the initial guidance due to lower North America and international earnings, partially offset by higher aerospace earnings, lower SG&A expenses that is the result of the execution of a strong budgetary control environment, and lower taxes.

Marginal return on sales was 32% of the decline in revenue and includes the effect of acquisitions, inventory reductions and realignment. The full year earnings per share decreased 43% to $3.13. That's from $5.53 a year ago. This decrease is the result of a 15% decline in sales for the year, obviously as a consequence of the global recession. The decline in operating profit was 38% of the decline in revenue for the year, and again, includes the effects of acquisitions, realignment charges and inventory reductions.

Moving to slide seven, just laying out the components of the earnings per share decrease in the quarter versus the same quarter a year ago on a segment basis. The puts and takes are as follows: Decreased revenues of 34%, translating into lower operating income, realignment expenses of $15 million, inventory reductions of $80 million, there was a $30 million improvement in corporate general and administrative expenses, and there was less other expense of $41 million due to litigation charges last year of $20 million and of course the $19.5 million that I just mentioned of the LIFO inventory gain.

Tax expense was reduced by $70 million due to decreased earnings and fewer shares outstanding impacted earnings by $0.02. Addressing the full year for a moment, while not on this slide, revenues were down 15%, the decline in operating profit was 38% of the decline in revenue, and again, includes the effect of acquisitions, realignment charges and inventory reductions. Corporate SG&A declined 21%. Interest expense was up 13% obviously due to more debt outstanding and other expense was down 34%, again due to the LIFO gain that I just mentioned a little while ago. Also, there was a favorable insurance settlement that we discussed in the last quarter.

Moving to slide eight, looking at sales, the top line you can see they decreased 34% to $2.2 billion from $3.3 billion last year. Of this 34% decline in sales, 32% related to base revenues. Acquisitions contributed 3%, and currency translation reduced sales by 5%, which most of you know the currency impact was mostly due to the international Industrial segment, mainly the Euro. For the full year, sales declined 15% to $10.3 billion from $12.1 billion last year. Base revenues were down 16% in currency translation and acquisitions offset for the most part with acquisitions adding 4.5% to sales.

Moving to slide nine and focusing on segments for a moment, commencing with Industrial North America. North American sales declined 33% in the quarter versus the same quarter a year ago. Base revenues, however were down 35%. Acquisitions added 3% to sales, and currency translation reduced sales by 1%. Decremental marginal return on sales for the quarter was 28% and that includes the effects of acquisitions, realignment charges and inventory reductions. For the year, base revenues declined 17.3%, acquisitions added 6.4%, and currency translation reduced sales by 1.2%.

So at this time to slide 10. Continuing with the industrial segment, moving to International. Revenues declined 43% in the quarter versus the same quarter a year ago. Currency translation was a deduction to revenues in the quarter of 9%, and this compares to a negative 13% for the previous quarter. Acquisitions added 4% to revenues in this segment, and base revenues declined 38%. Fourth quarter margin return on sales was 37% of the decline in revenues and again, includes the effects of acquisitions, realignment charges and inventory reductions. For the year, sales were down 19.5% on base revenues while acquisitions added 5% to sales and currency was a detraction from sales of 7.7%.

Moving to slide 11, focusing on the aerospace segment for a moment. Aerospace revenues declined 12% in the quarter. Margins decreased 130 basis points; however the decremental marginal return on sales was 25% for the quarter and for the year, it was positive at plus 25%. Revenues declined as a result of the commercial side of the business, OEM and MRO, mainly spares.

Moving to slide 12, our climate industrial control segment. As we've mentioned in previous calls, obviously that segment is very dependent on automotive, heavy duty truck, and residential air-conditioning. Base revenues declined 31% for the quarter, year-over-year, and currency translation was a deduction to sales of 4%. Margins as a percent of sales were 0.5% for the quarter and decremental marginal return on sales was 19%.

Moving to slide 13, just to touch on orders. These numbers represent 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 as most of you know, aerospace is reported using a 12 month rolling average. As you can see from this slide, orders are down 38% for the June quarter just ended. This compares to minus 34% last quarter and a positive 8% a year ago. Weakness continues to be seen across end markets and geographies.

North American orders for the quarter declined 40% year-over-year and last year at this time orders were positive 4% and this compares to minus 35% sequentially from the March quarter. A portion of this downward trend is due to tougher comparisons a year ago. Industrial international orders declined 43% year-over-year., up against a positive 8% last year. and this compares to a minus 41% last quarter. Aerospace orders are down 22% for the quarter which compares to a negative 12% last quarter. and a positive 23% a year ago. And in the climate industrial controls segment, orders are down 31% for the quarter, up from the negative 36% last quarter and a minus 7% a year ago, so showing some improvement there.

Just moving to the balance sheet, a quick review. Parker's balance sheet remains solid. Cash on the balance sheet at quarter end was $188 million. Commercial paper outstanding was $355 million and this is down $321 million from last quarter. Inventory was reduced another $81 million this quarter, reaching $327 million for the year. Accounts receivable went up a little at 53 day sales outstanding. Weighted average days payable, however, increased three days in the quarter, contributing to the cash flow.

On slide 15, you can see the operating cash flow for the quarter was a record $413 million representing 18.7% of sales and for the year, cash flow was $1.1 billion, 11% of sales. Of the $1.1 billion in cash flow, we utilized $994 million to advance the growth of the Company, $270 million in connection with capital expenditures representing 2.6% of sales and $723 million for acquisitions. $610 million was returned to the shareholder through share repurchases of $448 million and payment of dividends of $162 million. As of a result of this, debt increased by $250 million year-over-year but debt has been reduced by $584 million in the last two quarters. No acquisitions closed in the quarter and share repurchases were nominal. On slide 16, you can see that the debt to total cap ratio is down to 35.2% and on a net basis, 33.3%. The pay down of debt remains a focus as evidenced by the reduction in the last two quarters, again of $584 million.

So let's move to guidance on slide 17. The guidance for fiscal year 2010 is shown on slides 17 through 19. On slide 17, the guidance for sales and operating margin by segment has been provided and on slide 18, guidance has been provided for the items below segment operating income. Slide 19 summarizes the guidance on an earnings per share basis. As you can see from the slide and as Don said, the guidance for fiscal year 2010 for earnings per share was projected to be $1.25 to $1.75. Please remember that this forecast includes acquisitions that have closed to date and excludes any acquisitions that may be made in fiscal year 2010.

The full year guidance assumes the following: Decreased revenue approximately minus 8.7% to a minus 12.5%, segment operating margins as a percent of sales in the range of 7.2% to 7.6%. Corporate and admin costs that are in the range of minus 8% to plus 11%, interest expense in the range of minus 6% to plus 3%, and then other expense in a range of plus 12% to a plus 25%. versus fiscal year 2009 and the tax rate of 30%. To provide just a little more clarity on the guidance for the year, the split in terms of sales first half, second half are 47%, 53%, and the earnings per share is heavily weighted to the second half.

As a reminder, the call, I want to limit it to one hour today so please honor the request of one question and one follow-up, and clarification is needed on a question, please feel free to have a follow-up question but then please get back in the queue if need be. I would appreciate it if everyone would adhere to this request. So at this time, I'm going to open the call to our standard Q & A session. Thank you.

(Operator Instructions). Your first question comes from the line of Henry Kirn of UBS. Please proceed.

Good morning guys.

Good morning Henry.

First good performance on the SG&A line this quarter. Could you talk a little bit about how much more room there maybe to cut SG&A going forward?

Sure. I think you can see that we've made great progress on the corporate SG&A. We had $30 million of difference. We worked very hard at doing that. and everybody is working really hard on the budget. so I think what is happening here though is there's nothing being done and people aren't doing much at all and that's going to be very difficult I think going forward. I mean there's a certain amount of expense that you just have to incur and I think going forward you can see that number is increasing a little bit.

The fourth quarter that you're seeing is an unusually low number just because of the way some accruals worked out but I think that going forward we'll have to do a little more spending just because the budgets have been so tight that there's been no activity taking place. On the other hand, I think we made the 10% cut, and I think that is reflected in the numbers for fiscal year 2010, so Don can comment if he would like, but I think that's pretty much built into the numbers that you're seeing. So Don, Tim, if you want to add anything to that?

Well I don't think, this is Don. I don't think that we're going to see any appreciable further drop off in the percentage. I think with the reduction in sales, of course we're going to try to maintain at least the percentage that we had this year, so that will mean additional adjustments, if we continue to drop in sales like we have dropped but as a percent of sales I think we'll end up pretty close to where we are now would be my guess, so that's just what my feelings are on that.

Henry, this is Tim. I would just say that you should be aware that our target on that category is not to exceed 1.5% of sales and try to work it down to 1.0% of sales and in normal times that's what we would be doing. Very very pleased that actually this year, we were down slightly from 2008. We were at 1.6% on the corporate G & A in 2008 and we actually were able to bring it down to 1.5 for the year, actually 1.3 in the quarter, so that was a lot of hard work. One thing I would caution though, there is a lot of in this category a lot of incentive pay geared to Parker's share price and of course if that share price would go up, which we're certainly all working like the dickens to make happen, then those numbers could go up a bit, but the target is 1.5 and work it down to 1.0 and we're pleased to see it come in at 1.3 on the quarter.

That's helpful. Is it possible to chat a little bit about the impact of LIFO liquidations as we go into the first half of your fiscal year?

Well, we can talk about it. It's very difficult, of course and the problem with LIFO is it always, you have to wait until the end of the year and work backwards to do it and we had two dynamics going on. We had liquidations of inventory that were continuing. and then we did have some very significant decreases on some of our raw materials that came right towards the end of the year so it was a windfall. I mean, three quarters we had very little adjustment and almost all of this credit you see occurred in the last couple of months, so it is a very difficult one for us to forecast. Frankly we don't see much out of LIFO next year. We don't see prices going down anymore, but we're not seeing them rise for a while either, so we're thinking LIFO would be relatively benign in FY 2010.

Thank you very much.

Your next question comes from the line of Daniel Dowd of Sanford Bernstein. Please proceed.

Good morning, Daniel.

Good morning. I was actually, given the terrific work that you guys have done on inventory and the implications that it has had for operating cash flow, how should we think about operating cash flow next year? It seems like at some point you'll get to the end of your ability to take down inventories so can you just give us some thoughts on how that's likely to rollout across the year?

Yes, this is Tim again. The forecast we've just presented you with built in there. The expectation is to generate 9.5% of cash flow from operating activities and we would think we were going to incur about almost 3% in CapEx, and the reason that's so high is theres some big, some real of course strong years 2007, 2008 some high approvals and those are working their way through the pipeline if you will, so the CapEx that we've had this year which I think is a little over $270 million, we think will also be a little over $270 million next year just because of that in the pipeline. There's a lot of projects that Don mentioned earlier that have been put on hold or cancelled but nonetheless those will come through so we're looking at 9.5 from operations, after CapEx, 6.5.

So if you start to believe that aggregate demand is going to come up, are you going to start to build inventories or do you have enough of just in time that won't be a big impact on your operating cash?

That's something again we're planning on right now as a matter of fact. You're asking very good questions. We have already sat around the beginning of this week talking about how will we respond to the upturn when it does come, and we do not want to having suffered all of this pain, and we do not want to rush to add people back in or to rebuild inventories and so we are going to work that very diligently. Would inventories go up some? Absolutely but we'll try to contain it.

I think Dan, this is Don. I think on the inventories just one last point is that you can assume that we're at about $0.125 per dollar of sales right now per $1 of inventory, and that works both directions, so if sales go up we'll probably add $0.125 and if they go down we'll reduce it at least $0.125 and we're trying to get to $0.10. We haven't gotten there yet, so that's kind of the way we would look at it here.

One last quick one. So how long do we think it's going to take the cost cutting in Europe in particular but industrial international in general to be complete?

Okay. I knew sooner or later we will get into this, so we'll try to lay it out right up front in what we're looking at. We told you at the end of the last call that at that point in time, that we had incurred $30 million in cost and we had generated already $30 million in savings, so it's about neutral. All of that we thought of ultimately but we had more to do, and ultimately we were working to create $120 million of ongoing savings, and we said we thought in order to get there by the end of the fiscal year we would have incurred $45 million in costs. We would have offset that with about $40 million in savings within the year out of that $120 million and that's pretty much where we finished up.

The realignment charges are a little higher, over $50 million because there are related costs that go along with it. but basically we did what we told you before and so as of this year, if you will, we incurred the 45, it will generate $120 million although we only realized $40 million in this year so it will be $80 million incremental next year. Just an additional point of information, as subsequent million have gone on very recently we told you we knew we needed to do more in certain parts of the world who were hit harder and probably had to do even more and so within this plan for FY10 that we've given you today is another $40 million of restructuring charges which will save us $40 million per year going forward, so it's not the same multiple but it will keep on giving so that's pretty much how it all stacks up.

Thanks a lot guys.

Thank you.

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

Hi, good morning.

Good morning Mark.

Tim, you might have actually just helped to answer the question about why the international margin expectation next year is so low and it would be nearly a 40% incremental on your sales decline. Is that where this additional $40 million of charges is going to be centered?

Yes. The preponderance, was that Mark? The preponderance will be in international and quite frankly in Europe. What we're anticipating we will incur, by design we will incur a lot of those costs in the first two quarters in the fiscal year and then start realizing the savings and by the end of the year, be neutral for the year but have those savings then going forward from there.

So well wait a minute then. If it's neutral for the year then your incremental margin for international should be your more normal like 30% or so, so why is it 40%?

You're talking about the 40% incremental in the second half of international Mark?

I'm talking about your full year guidance for FY 2010 for international. It's that margin cut in half.

Because there's $80 million, remember in fiscal year 2009 that moves forward to fiscal year 2010, so it's neutral. The cost and the savings are neutral within 2010 but there's savings from 2009 that are moving in.

All right, maybe I'll follow-up off line.

Yeah, I can walk you through those numbers Mark.

Mark, before you go, one thing that is very important, I think that may get to your question is that as you know, the cost of doing these realignments in Europe is two to four times more expensive than it is in North America, and that's just by law and by policy and it will cost us two to four times as much money to realign, we still have to do it if it's compelling, we have to do it but it is much much more expensive so there's definitely a penalty factor on the marginal ROSs, the incremental ROSs because those realignments do cost much more.

But then you're going to make it back in the second half or is it going to be more like a run rate thing and we really have to wait until part of FY 2011 to really recoup these savings?

Yes, indeed. Some of those will, we're going to try to make them as neutral as possible again, but there will be I'm sure there will be some that will not be realized until we actually carry over into 2011. But I think it's more the higher cost factor of making those realignments creates a less favorable MROS if you will.

The other thing Mark is, this is Don, is that there will be additional inventory reductions in Europe because their sales drop off has been the most dramatic of all of the regions, and as a result of that we'll have to make further adjustments in Europe. That's going to impact the results as well. The MROS.

Okay. Great. Thanks for the help.

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

Hi, good morning and congratulations. First question, sorry to focus so much on the international, I just want to make sure I understand, in the first half of the year, I mean, I'm assuming do you see losses in the first half of the year and then I guess my question is, at what point do you think international margins run rate or are more equal to get back to where the US margins are, or the North American margins are, and I guess just a follow-up question, Tim for you, you've done a very good job holding your decremental margins at 30% but as we come out of this how should we think about your incremental margins?

Okay, maybe if I could even start with that first because I do want to, I'm extremely proud of the team here, and what's been done on these incremental margins or marginal ROS, and these things are not possible unless you plan well well in advance, you will not contain these things to what they are, so as you know, for the year, it is a negative, it's a 38% on the downturn for the Company, but if we back out the acquisitions, just the acquisitions we've made this year, it reduces down to 29%, so it's below the 30%, there is a target and below that, and that does not allow for the restructurings, the realignment, the inventory reductions.

All of that is in that number so if we were to adjust for that and we do our best to try to do that but you can't get it exact we're down in the low to mid 20s so great job on the quarter, likewise 32 reported, 28% without acquisitions and again without the realignment the inventory reductions were down in the mid 20s so just a stellar stellar job. Now, on the recovery and that is exactly what we're talking about meeting, what are we going to do on the upside? Well clearly we want at least 30% Jamie and if we do it right we'll yield more than 30%, especially in the early days and that's how we will get ourselves back to where we want to be. So I wouldn't say that we know--

But I guess how much more than 30% because we always on the downside, we always, things are always much worse than we think, but the same happens on the upside so that's why--

Well in the short-term, I guarantee in the short-term, I won't give you any numbers, but they will be better than 30% because we will not be rehiring people. We will not be trying to rebuild inventory, et cetera, to the same extent and they will be higher, but I'm not going to commit to what those will be but I guess it would be higher than 30% in the short-term.

Jamie, I think you can go back and look historically at the numbers and you'll see that yes, they really do, they are well above 30% and I think that in this particular downturn, of course we had to because it was so bad but we reacted I think more quickly and things -- more deeper than they've ever been before, so I think if you look historically and then think about what we've really done internally, it will give you a pretty good idea.

Great. And then sorry just on the international front for first half versus second half, when do international and US margins are more comparable to one another?

Well I'd say that it's going to be all 2010 will be difficult to see that happen. I think we need to get through 2010 and I think into 2011 you'll see them back to parity. Again what we just told you about announced this morning is another $40 million in realignment within the first two quarters of the year and then savings to come out of that, so that's a wash but the pure savings which will all be there will be in 2011 so I think it's in 2011, Jamie.

Great. Thank you very much.

Yes.

Thank you, Jamie.

Your next question comes from Ann Duignan of JPMorgan. Please proceed.

Hi, good morning guys.

Good morning, Ann.

A couple of quick questions, first just clarifications and forgive me if you talked about this. I was a little bit late jumping on. Do you have any assumptions for pension costs in your outlook for operating margins by division?

We do. We do. Ann, just to talk about pensions for a little bit. The first thing I'd like to say is that our pension plan isn't at risk, so that's a good thing. The other thing is the discount rate did come down more than what we had anticipated even just a few months ago working with our Advisors, so obviously you can see in other comprehensive income that we did take a hit to the shareholders equity as a result of higher unfunded balance in the pension plan, but we have a credit carry forward balance because in the past, we've always contributed more than what was required and so as a result of that, we're going to see about $32 million for the entire year next year as additional pension expense and that's built into the guidance that you see.

And is it at the unallocated corporate line or is it baked into operating profits by segment?

Yes, it's baked in, although I will say that the majority of it is below D& E. In that other category.

Okay, that's very helpful, and then just on climate and industrial controls, it strikes me that that timing leveraged to the automotive sector. I mean I know it's also residential and air-conditioning and we've had a cooler than normal summer this year so that's probably not helping, but on the automotive side, maybe Don, a lot of other companies are talking about seeing a pick up in schedules for automotive production sequentially, at least going into Q3 and Q4. Can you talk a little bit about that, and what you might be seeing out there, and then is there upside to your guidance for that division?

Yes. This is the kind of in general, let me just maybe I'll hit markets in general and automotive is one of those. I think on a year to year comparison basis, really all of the markets that we're looking at are really flat to down and when you look at sequentially last month or so to this month, keep in mind that the automotive companies were shut down here, at least some of them for extended period of time we'll be going into probably some retooling in the Fall and so forth, but the indication right now is that there is a little bit of an uptick in automotive, but the thing is when you think about Parker, you really have to look at the individual business units themselves, because we could be on platforms that are going to do well, specific models or styles and brands if you will, that will be doing well and we could be on those that are not forecasting very well so it's really a mixed bag, and that's the reason why we really don't try to forecast that at this level. We get down into the group end of the division level and they look at their specific platforms they are on and they do their projections based on the projected build of that platform. So yes, I think to your point, we have seen a little bit of an uptick in the automotive which frankly which was good to see.

What you said on the air-conditioning side is true as well. It's been cooler than normal so I think that business is still going to be suffering here and plus the housing starts of course are still down relative to where they were before. I mean there's 400,000 compared to 2 million, so housing starts even though they ticked up a little bit is nothing to write home about so that group and then the third piece of that group is really the heavy duty truck market. Of course they're talking about I believe that the truck build was like 115,000 going to maybe something higher than that this coming year, but I'll have to, I'll believe it when I see it I guess. We've been hearing truck builds going up for so long, I'm not sure what to believe there, so I hope that helps you a little bit. Yes, we do see a little bit of an automotive improvement. Hopefully that will continue and it's baked into that CIC plan.

Okay, that's very helpful and one final just real quick kind of philosophical question for you, Don. Given how difficult it is to restructure European operations and the cost of restructuring over there, will this change maybe your acquisition strategy in the next cycle? Will you be less or more hesitant to acquire assets that are western European based?

I think we're going to be very selective. Let me put it that way. I think the other thing that I think we are certainly going to be reviewing is the where we do the manufacturing, how much outsourcing we do, where we outsource to, whether we in source to other regions, what components and products we manufacture in Western Europe. We also are evaluating a philosophy of design assembly test as opposed to having to cut all of the metal maybe some of these operations really should be doing more assembly at test and the de-assetize the region.

There's a whole host of things that we've had several meetings on here because we're frankly not happy with the cyclicality impact and the inability that we have to manage that region in, like we do other regions, from an employee standpoint when things head south, so yes, there's a whole host of actions and strategies that we're looking at to make sure that going forward, we're going to be taking the right actions to put us in a much better condition there in any future downturn that we should see. As far as acquisitions we still feel that if the acquisition is something that would be synergistic with our operations, we would still look at it, but we're going to be looking at it with the thought that we might not be manufacturing everything long term in that particular part of the region.

Okay, guys. I'll leave it with that and if it's any consolation you're not the only ones finding it difficult to cut costs in Europe so appreciate the color. Thanks.

Thanks, Ann.

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

Yes, thanks, good morning.

Good morning, Nigel.

Great cash flows this quarter. Another good performance there.

Thank you for noticing.

Well you can't help but notice. The 2010 plan based on visibility, can you just maybe run through what your plan assumptions are and maybe just highlight what you're seeing in terms of channel inventories versus real demand and also when you expect sales to start inflecting upwards?

Nigel, this is Tim. I think in terms of the inventory, this is interesting, and when we talk to our people out in the field now, we again aren't getting as many orders as we used to but when we get an order people want the thing shipped tomorrow, so that's a good indication that nobody has inventory out there and so that maybe answers part of that question. We think they're low, and any demand we see will have to get it through the shop quickly, and in terms of the recovery here and everything else, and what we're seeing, again, what we've given and laid out here for you today is frankly, I mean on a real high level basis, is no recovery at all. These next couple quarters, kind of we are where we are. July and August, in fact the next quarter is going to be less than this quarter.

This quarter was destined to be lower than the first calendar quarter because no one had backlog that they carried over and so orders stayed down so it was weaker and the next quarter, July, August, September will be weaker again because everyone is on vacation and holiday and extended shut downs. Now, having said that, we are expecting that when they come back in the beginning of September, they will be ordering, there will be a bit of an uptick. We don't see a big benefit in the second quarter but a slight uptick from the first and then we are at this stage hopeful there will be a modest uptick in Q3 and Q4, not a lot but we're hoping and that's what we've constructed this all around.

That's really helpful and does this come in supply to all segments so you expect those across all four segments, maybe not as much but certainly in the short cycle businesses?

Yes, exactly right. It's very broad based. That would be a very broad based type recovery that we would be looking at at that stage. We do have some markets right now that are actually again we've said it before, we'll say it again. There are some markets that are still doing okay. Those are energy, alternative energy, or just energy related are decent markets. Anything that's life science pharmaceutical is doing okay. Anything that's food and beverage also seems to be doing okay for us, but after that, pretty much everything else is not so we expect that to be a fairly broad based recovery when it comes.

And if I could just dig in a bit deeper into the 2010, looking at CIC revenues and looking at error margins, both look quite bearish. I know you just answered Ann's question on CIC, but that's probably a shorter cycle and I would expect that to show slightly better trends relative to the other segments and error margin is down about two points year on year on a very modest revenue decline. Could you just address those two points?

Sure. Aerospace, we've been talking about this for some time, Nigel, but we are seeing a decline in the commercial after market. Let me just run through aerospace for a moment. Commercial OEMs, which really has been the bright spot for a long time, has been on an uptick and a boom, and commercial OEM is actually projected to be down as well as the after market side of it. On the military side of things, it's going to be relatively flat; however, military maintenance repair and overhaul particularly on the spare side is expected to be down a little bit too.

I think you saw that other companies coming out of and reporting that commercial after market expected to be down in the range of 8 to 10% and quite frankly, we're not seeing a whole lot different than that, so in aerospace, there are really two things that you're seeing there is you're seeing a decline in the commercial after market side of the business as well as business jets and regional jets are off. General aviation and business jets are off 40%, so you're seeing that effect that market as well as the decline in commercial after market, the revenue passenger miles are down, and in the second half though one of the things that I think when you really analyze the numbers you'll see that we do have some retrofit programs that are coming back in in the second half of the year that's really going to help because those are high margin business, so pretty much so that's what we're seeing there. We have new wins as you well know, so we're incurring a lot of R & D so two things to remember. R & D expenses are higher on lower sales, and the lower sales are mostly attributable to the commercial side of the business. Does that help with aerospace?

It does, and CIC?

CIC, we did a lot of restructuring in the past. They were some of the first to go out and do all of the restructuring that they did and so when you look at the marginal return on sales of the decremental, whatever you want to call it I think you'll see that climate industrial controls is much better than the other segments because they've done this restructuring and so they're starting to get some benefits from that, but they're really struggling because of the automotive and the housing, so we haven't built a whole lot into that. The improvement that you're seeing is the result of the restructuring more so than any big upticks in their markets.

That's really helped just final clarification from Tim's comments about the quarterly build. Should we think about second half growth year on year within the plan?

You're talking about, yes, there's about 13% sales volume increase first half to second half if I understood your question.

Okay, that's really helpful, thanks.

Yes.

One other thing I would just want if I could jump in on this thing just I don't think we've touched on it yet. So when you work your numbers and so forth, first half-second half is say first half continues really much a continuation of what we seen off the last quarter, maybe even a little weaker, but then a little recovery in Q3, Q4. You know that we wanted to maintain a 10% operating margin here. It looks like for the year, we closed damn close to that for the Company, we're very proud of that that we could respond that quickly to hold virtually hold that 10% margin for the year. It appears the first half of next year, the margin will probably be more like 6%, given even weaker conditions where we are, even weaker condition, but we would expect in the second half of the year, we'll give a little recovery to be backed up at that 10% level, overall that gives you about an 8% for the year.

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

Don, you presented a fairly negative picture here compared with what I'm seeing on CNBC and lots of economic pundits who are forecasting even that GDP will be up this quarter, but I don't see any anecdotal evidence that would support that, can you give us more detail on what your economic outlook is, and why the coming two quarters are going to be so weak and so on, because a lot of your business is not necessarily, it's related somewhat to current economic conditions, not with the normal cyclical act.

Well, Alex, I think we hit on a couple of these. what we see in the next couple of quarters, first of all, we're in the summer months, so we'll see the normal shut downs in the summer months, the automotive plants are just starting to come back, and most of the rest of our markets are really flat. Like I said before, the housing which drives a lot of construction equipment and other related markets is ticking up but we're ticking up, but we're ticking up off a pretty low level so really nothing to write home about as far as any major improvements. You get toward a second quarter or the last quarter of the year, now you're into the holidays and in Europe, no one works August and most everyone is off December, so I mean, that doesn't help the situation.

I will say that we see a slight uptick in China and I think that will be one of the regions that will probably continue to show improvement going forward first before others and I think Europe will probably be the last so I think witness will be China, North America, Latin America and then Europe last. Keep in mind that half of our industrial business is international so that really does impact us as well, but I really can't point to any significant trends that I see. Of course, we watch a lot of different ISM index and I think that's maybe at a 42 or 44, it's going to continue to go up, so but--

Still negative.

It's still negative and we've got to get over 50 so I don't see that, I don't hear much in the way of stimulus. They talk stimulus and I think we've hired some police officers of late but I'm not sure that anything has gone into building anything or any construction or infrastructure related projects. That's the difference between North America and China. China is pretty much all infrastructure, where we are minimally infrastructure and frankly I don't think they've been able to spend much of the stimulus, so even though they passed all that stimulus $700 billion I think they've only spent 10% from what I understand, so I don't see any of that happening or changing anything any time soon. Passenger revenue, miles on aircrafts going down, we heard just recently, Continental is laying off another couple thousand people, employees, so we know how tough that is.

The truck build rates I mentioned earlier, we think that might be a little bit going up but I'm not going to take any of that to the bank, because we've been hearing that for too long, so again, really nothing that I can point to and again, I don't know if what we hear on the airwaves is trying to get the mood changed, so that maybe someone feels like buying something, plus the last thing is what I brought out earlier in my opening was the unemployment rate. Before you can really get things moving here you have to have people that have some money to spend and as that unemployment rate goes above double digits, already in Ohio it's well above double digits, into the double digits, and I think that's where the rest of the country is heading, so I don't want to be sounding too negative, but I just can't be overly optimistic at this point.

Okay. Second question is in this kind of environment that the large strong companies generally benefit because competitors get weaker, go out of business, fall behind in R & D and also maybe some of them come up for sale, so is this affecting your market share? Are you seeing gains against weaker competitors and also are there any acquisition opportunities that are being brought forward by the recession?

Well, Alex, I'd say on market share, I would say we're holding our market share. I don't think right now that there's been any major shifts in market share in any direction. Everyone is really hurting so bad here, I don't think anyone is out there trying to dive internal injuries and impose more internal injuries on themselves by doing crazy things in the marketplace, so and on the acquisition front, I don't see, well first of all we aren't into acquisition mood right now. We're in a pay down the debt mood, maintain our debt ratings, pay dividends, secure R & D programs that the major ones that we have going on which we are going to continue to fund, so that's really the mode we're in. Now it's not the acquisition mode but having said that I haven't heard of many acquisitions that we are not talking about many acquisitions internally. We're probably not going to get into an acquisition mode until well in the next fiscal year at the earliest. There could be some I think like you said earlier, there could be some weak competitors out there that might become available but we're not going to entertain anything at least throughout the balance of this calendar year and going into the next calendar year.

Okay, thanks.

Yes.

Thanks, Alex.

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

Tim, Jeff Hammond.

Hello, Jeff.

I just wanted to follow-up on the break out first half-second half. So you gave 6% margins first half, 10 the second half, kind of blended a little bit better than eight and yet your guidance is 7.2-7.6.

Yes, he's just rounding up, Jeff. I mean the first half is a little lower. The first half is usually like 5.5 or something I think at the mid point or something like that. It's lower than that I noticed when he said that.

Okay.

Well, you caught me, Jeff.

I just wanted clarification and then Pam, do you have the real decrementals by business excluding realignment et cetera for the quarter?

Yeah, I do. For the quarter, if you take out all adjustments North America is minus 24%, rest of world is minus 29, aerospace minus 21, and CIC minus 16.

Okay, thanks.

Your next question comes from Eli Lustgarten of Longbow Research. Please proceed.

It's close, right?

Eli.

Well I get called a lot of things. At least we've still talking. Well first question, foreign currency impact on earnings a little over 4% in the quarter on the sales and more importantly what foreign currency do you have for 2010 embedded in these numbers?

The foreign currency for the year is interesting because it started moving in the opposite direction in the fourth quarter and as you know, I'm trying to think it's over about $450 million or so on the currency impact for the year. It was over 500 and I think it came back down to 450. It's very difficult for us, okay $490 million they gave me, very difficult for us to really quantify that at the bottom line impact. It's kind of on the margin and I guess if you did that in the five or 6% range of that, it's probably not far off, Eli, but we really can't get you an exact number on that.

You said you have about a five or 6% benefit of impact?

Impact. It goes the same way. If your sales are down, if your costs are down --

Except for Caterpillar which went the other way. And then the real question is the foreign currency impact embedded in your 2010 outlook. Do you have any foreign currency there?

No, we don't. We're not that smart, so we do try to put certain hedges in place to protect ourselves against currencies moving too far in one direction or the other, but in the forecast we do not plan. What we do I think we said this before, what we do is we look at the rates, excuse me, we look at the exchange rates the first of March and those are pretty much established as the Parker rates and we kind of go forward on that basis. We do not build in anyone's presumption what's going to happen there.

And you talked a little bit about China but can you go over what you're doing in China, how big is it representative of 2009 sales and what are you doing to try to take advantage of what seems to be the leading growth engine or the only growth engine in the world in the moment?

Well, Eli, this is Don. China, well let's talk about Asia in totality represents about maybe 10% of Parker right now.

Is half of that China?

I'd say a little more than half of that is China, and we are growing there at a very nice rate. It was like in the 20 to 30% a year levels here up until just recently. I think we'll be back up into the very high -- at least into the teens or probably near 20% growth rates once their economy starts turning around and is on the up swing because we were growing market share, penetrating and really participating in the economy there in a big way so I think that China has a lot of potential for the Company going forward and I think we'll participate in that.

And two of the biggest markets are industrials and farm equipment. Are your OEMs telling you about production increases or decreases for 2010? What are you hearing from the major customers and the rest of this calendar year we know is difficult but what are you hearing for the year 2010 or are you hearing anything yet?

Well I would say here in the states really not nothing. I haven't really gotten any significant improvement in schedules or outlook. I think everyone is kind of in the same mode here, not sure what the next couple quarters is going to bring. I think that's where we are seeing a little uptick for instance in China in that construction area which has to do with the infrastructure buildout but I would say in North America, really nothing significant right now.

And Europe is expected to go down next year?

Yeah. Europe likewise. Nothing significant right now either.

All right, thank you.

Thanks, at this time we'll take one more question, please?

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

Good morning everybody. Thanks for taking my question. Are you there?

Yes.

We are, sorry, Rob.

My first question is, could you talk a bit about the OE versus distribution split on total Company basis, one of the elements of the Parker story has always been relatively more stable performance in the distribution piece. Can you tell us what you saw as you're exiting the quarter and can you talk about what expectations are on that kind of a basis built into your model for 10?

Rob, this is Tim. I think what we've seen has held true historically today and that is that the distributors are not down as far as the OEs. Having said that, in this economy, they're down significantly as well, so if you're seeing North America down for instance in the order of minus 35%, that translates into OEs down minus 45 and distribution minus 25, so order of magnitude.

Rob, I get buried in these numbers, these market numbers. We actually did see a pick up in June in distribution, not that one month makes a trend, but the longer that this recession continues, the bigger chance that distribution will continue to tick up even more.

Okay. And as you were putting together your forecast for fiscal 2010, what do you assume in terms of your own performance relative to market? Are we, should we look at your numbers and assume that your end market forecast would be for a bit worse performance because you expect to gain share or are you completely share neutral?

Well, the way we do it here, Rob, is basically at the business unit level, at the division level and what they do is they look at all of their markets and frankly, the various divisions may participate in the same market, for instance construction market but one could be in one part of the construction market and the other in another part and one would be forecasting something very good and the other not so good because of the specific products that they're on. So what we do is we do it at the lowest level in the organization which is our division level, our business unit level and they look at all of their Markets and all their customers and alt of the forecast from their sales inputs from their customers and projections and so forth and then what we do is we roll up the divisions. We don't starrily roll up all of the markets for all of the divisions and all of the detail that you might be able to imagine because there's 135 divisions so we think we get it pretty, a pretty good roll up and a pretty good definition on where exactly our sales are coming from and so forth. I don't think that anyone has put in significant market share gains this year. I mean, there could be market share gains here or there but I don't think anyone has projected that in any of the division numbers, and when we roll the divisions up then that gets to be our group number and then of course the group numbers are rolled up to the corporate level so that's pretty much how we do it.

All right thanks, Don and Pam if you could just help us with a modeling question. What kind of revenue will be carried into fiscal 2010 from acquisitions?

It's a very small portion. 142 million, 1.4% is what it works out to be. Michelle could we take one more question? We're in a good mood here today so we'll take another one.

Certainly.

Your next question comes from the line of David Raso of ISI Group. Hi, a quick question on North America, the incremental margins of 24 per from using your mid points. What's assumed on price versus cost? It was interesting your distributors had noted to me that you did not put any or many at all price increases through for July 1. Could you just give me some feel for the price versus cost relationship you're baking in?

Yes, we are pretty much, we've pretty much recovered whatever cost inputs that we have throughout the course of the year. What the distributors would be responding to you on would be maybe specifically the July time frame, but when you look at the entire year, David, we've had increases at the distributer level and throughout many divisions throughout the fiscal year because earlier in the year, raw material inputs were still going up and we were passing those on on a regular basis. What they probably if you've talked to them are reflecting is the fact that they may not have gone or seen increases from us across-the-board into the July time frame because we've already given them increases earlier in the year.

And actually, David, this points to the LIFO adjustment that you saw. Again, there were some raw materials that did come down going in towards the end of the year so there was not, there really frankly wasn't the need to do that at that point in time.

So is the relationship pricing down net distributer OEM but costs down as much?

Exactly. As we've mentioned before, we tracked our purchasing indexes here. We tracked our sales price indexes, and we want people to stay in line with that. Hopefully a little bit to the good.

And on the restructuring savings there's $80 million left incrementally but also the days without pay program that you've been running internally--

Oh, yes.

What kind of savings do you expect from that? Obviously it's volume sensitive, if volumes pick up the program goes away but given your comments for the next two quarters what kind of days without pay savings are you baking into these numbers?

Well I'm going to check with Pam, the annual savings on that was $100 million I believe.

Yes.

We gave you that before and that's about what it's running so again, just going over the numbers we started the fiscal year at 61,000 employees. We did some big acquisitions right at the beginning and we got to 64,000 employees, we were finishing the year down around 50,000 so that's 14,000 people, about a 20% reduction in full time employees and now in addition to that we have done the reductions on salary and hourly and those are saving about $100 million per year. Now, those will be the first of course that will go away. We start to see any increase in business. The first thing that we'll change will be I tell the people that we're going to restore your pay. We don't want you off one or two days a week or a couple days a month. We want you here full time and we will restore that pay. That will be the first action that we'll take. But right now, David, it's $100 million a year.

One last question, the realignment in the quarter, which can you break that out for us, if you said already, I apologize.

The $15 million is divided among the segment operating margin, the different segments at the top.

At the top?

Yes, it's in segment operating margin in international, North America.

And within the segment there was $2 million in North America, $11 million in international and $2 million in CIC.

That's correct.

For your total of $15 million.

Thank you very much. I appreciate the time.

Thank you, David. Michelle, at this time we want to turn the call over to Don. He just has a few closing comments.

Okay so just a few comments. First of all, I feel very strongly that Parker is managing very well through this current recession. By pursuing the disciplined strategy that I outlined earlier and responding decisively where needed, our employees have stepped up and although the challenges were far greater than we could have anticipated I'm proud we have performed remarkably well throughout the year. Coming to the -- or looking at the next year ahead, we'll continue to focus on maintaining a strong balance sheet, we of course want to keep that leverage below 37% as we said earlier we're at about 35. I'd like to think we could end next year below 33, maybe even 30. We continue to pay down debt as we have done all year here.

We're managing for cash. Again we want to maintain that 30% MROS. We're going to continue focus on that and every region around the world. and then we want to maintain our cost at a level consistent with reduced demand so we'll continue to make adjustments as we see the need based on the demands that are coming in. Our plan is also to pay increasing annual dividends for the foreseeable future. We do expect and plan to pay dividends and increase those dividends year on year as we have over the last 53 years, and we plan to emerge certainly from this recession far stronger than we have ever been in the past.

So once again, I want to thank everyone on the call. There were a lot of good questions. Hopefully we shed a little light on those and we certainly appreciate the interest in Parker and throughout the balance of the day, Pam will be available for any further questions that you may have. So have a good day. Thank you very much.

Thank you very much.

Ladies and gentlemen, this concludes the presentation for today. Thank you for your participation. Have a great day.