派克漢尼汾 (PH) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter fiscal year 2010 Parker Hannifin Corp earnings conference call. My name is Shanika and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions).

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

Thank you, Shanika. Good morning, everyone. This is Pam Huggins speaking. I would like to welcome you to Parker Hannifin's first quarter fiscal year 2010 earnings release teleconference. Joining me today is Don Washkewicz, Chairman, President, and Chief Executive Officer; and Executive Vice President and Chief Financial Officer Tim Pistell.

Prior to beginning with the earnings release, just let me address a couple of administrative matters. First, for those of you 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 PHstock.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 again ask that if you haven't already done so, please take note of 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 have been reconciled to the appropriate GAAP numbers.

And moving to slide number four, the agenda. Again the agenda 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, concluding with a revised outlook for fiscal year 2010. The third part of the call will be our standard question-and-answer session, and for the fourth part of the call today, Don will close with some final comments.

So at this time I'll turn it over to Don and ask that you refer to slide number five, titled First Quarter Highlights. Thank you.

Thank you, Pam, and welcome to everyone on the call. I want to start with a few highlights for the quarter. Our results in the first quarter continue to reflect the impact of the global recession on our business, leading to significant declines in revenues and earnings in the quarter compared to last year. However, we have performed remarkably well considering the level of the global economic weakness and we are beginning to see signs that we are at the bottom of the cycle, and that does give us reason to be positive about the future. Our near term objectives remain the same as they have been. Number one is managing for cash, and we've been doing this now for the better part of a year. We want to aggressively manage inventory and working capital and I'll update you on our progress in these areas in a few moments. We're targeting a 30% MROS, excluding reductions in force, inventory reductions, and acquisitions. Our major capital projects of course have been under review and continue to be under review, and our acquisition activity is essentially on hold for the time being.

I'm pleased to report that we are achieving our objectives. We generated $260 million in operating cash flow in the quarter or 11.6% of sales, and that's well above our 10% cash to sales target. For the past nine months, we've been able to reduce inventory by $253 million. Our intention is to continue using free cash flow to pay down debt. In the first quarter, we further reduced outstanding debt levels by $162 million, bringing our debt to total cap ratio to 32.5% at quarter end, and you may recall last year we were approaching that 40% mark. So we've brought it down considerably. All of these actions are helping us maintain our strong credit ratings.

I'm also pleased that we were able to generate segment operating margins of 9%, which is approaching our full year goal of 10%. Our marginal return on sales in the quarter was at an impressive 30%, even including the impact of acquisitions, inventory reductions, and restructuring. So we're making great progress on an incremental basis.

I'm also very pleased with Parker employees throughout the world as they continue to manage our company effectively throughout this severe recession. In our markets, we're seeing a mixed picture with some markets beginning to edge higher sequentially, and although we do not anticipate material changes in our markets before calendar year end, we are cautiously optimistic that a bottom appears to be forming from a demand perspective. Our focus will continue to be managing for cash and maintaining strong margin performance for the foreseeable future, and this will put us in the best possible condition to benefit from the eventual recovery.

Reflecting all of what I've said, and these conditions and the trends in our business, we are updating and increasing our guidance for fiscal 2010 to the range of $1.55 to $2.05 per diluted share, and that's up from our previous range of $1.25 to $1.75 per diluted share. This earnings range reflects our expectation that MROS will be a decremental 28% in the first half, but will be a positive 45% in the second half of fiscal 2010. So with that, I'll turn it back over to Pam for a little bit more detail.

Thanks, Don. Turn to slide number six and I'll begin by addressing the diluted earnings per share for the quarter. As you can see, earnings per share came in for the quarter at $0.45 and this compares to $1.50 for the same quarter a year ago. Included in the $0.45 is $0.07 in realignment charges for the quarter. And this $0.45 exceeds the initial guidance due to higher sales in all segments of the business other than Aerospace, higher operating profits across all segments, lower SG&A expenses as a result of the execution of a strong budgetary control environment including lower incentive compensation. And these were all offset by higher other expense due to benefit plans and FX and then higher taxes due to required accounting in connection with the finalization of some tax audit adjustments. As Don said, decremental margin return on sales was 30% for the quarter. And as a reminder, this is the difference in segment operating profit divided by the change in revenue for the quarter on a year-over-year basis.

Moving to slide number seven, laying out the components of the earnings per share decrease in the quarter versus the same quarter a year ago, and this is on a consolidated basis, the puts and takes are -- a 27% decrease in revenues in the quarter, translating into lower operating income in all segments of the business, obviously as a result of the global recession. Realignment expenses, $19 million, this is $12 million net of tax or $0.07, and this compares to $2 million, the same quarter a year ago, which was $1.3 million net of tax or $0.01. Also, had a $31 million improvement in SG&A expenses, again, due to tight budget control, lower incentive compensation that I mentioned. And then of course lower interest expense of $2 million due to less outstanding debt and a lower commercial paper interest rate. Other expense was lower and this is on a consolidated basis, again. And that was $14 million due mainly to asset write-offs that occurred last year, not repeated this year. Lower taxes due to less income. However, the tax rate was actually higher due to required accounting in connection with the tax audit adjustments that I mentioned earlier. And then of course fewer outstanding shares impacting earnings by $0.01.

Moving to slide number eight and looking at the top line, revenues for the quarter decreased 27% to $2.2 billion from $3.1 billion last year. Of the 27% decline in sales, acquisitions contributed 2.5%, currency translation reduced sales by 1.5%, and the currency impact as you know was mostly due to the international industrial segment, mainly the Euro, and so that left the organic core decline in revenues at 28%.

Moving to slide number nine and focusing on segments, commencing with industrial North America, North American revenues declined 29% in the quarter. And most of this decline was base revenues, as acquisitions added 2% to revenues and currency translation reduced revenues by 1%. This resulted in a base revenue decline of 30%. Decremental margin return on sales for the quarter was a very positive 26%, and this includes the effects of acquisitions, realignment charges, and inventory reductions. Operating margins increased sequentially from 6.9% in the fourth quarter to 9.7% this quarter, nice improvement.

Moving to slide number 10 and continuing with the industrial segment, moving to international, revenues declined in that segment 31%. Currency translation was a deduction to revenues in the quarter of 3%, and this is versus a negative 9% for the previous quarter. Acquisitions added 5% to revenues, leaving base revenue decline of 33%. First quarter margin return on sales was 38% of the decline in revenues and again, including the effects of acquisitions, realignment charges, and inventory reductions. Operating margins increased in that segment to 7.3% in the quarter, from the negative 0.7% in the fourth quarter, so a nice improvement there.

Moving to slide number 11, and focusing on the Aerospace segments, Aerospace revenues declined 13% in the quarter. Margins decreased 150 basis points. However, the decremental margin return on sales was 24% for the quarter. Revenues declined as a result of commercial side of the business, mainly regional and business jets and general aviation as well as spare parts and the aftermarket side of the commercial business. Operating margins approximated 13%, comparable to the fourth quarter, but lower than last year due to the decline in the more profitable aftermarket side of the business.

Moving to slide 12, the climate industrial controls segment, base revenues declined 25% for the quarter year-over-year, and currency translation was a deduction to sales of 2%. There were no effects from acquisitions. And then margins as a percent of sales were 5.6% for the quarter. This is comparable to 6.1% for the same quarter a year ago. But decremental margin return on sales was a very respectable 7% for the quarter versus the same quarter a year ago.

Moving to slide number 13, addressing orders -- these numbers, again, just as a reminder, 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. Aerospace is reported using a 12 month rolling average. As you can see from this slide, orders are down 25% for the September quarter just ended. This compares to minus 38% last quarter, and a positive 1% a year ago. Weakness continues to be seen across end markets and geographies, but you can see that the improvement is very nice, going from 38% to 25%. North American orders for the quarter just ended declined 27% year-over-year, and this compares to a minus 40% last quarter and a positive 2% a year ago. Industrial international orders declined 25% year-over-year, and this compares to minus 43% last quarter and a minus 40% a year ago. So nice improvement in the international orders. Aerospace orders are down 23% for the quarter, which compares to a negative 22% last quarter and a positive 9% a year ago. And then last, in the climate industrial controls segment, orders were down 17% for the quarter, and this is up from the negative 31% last quarter and the positive 5% a year ago.

Now, switching to the balance sheet on slide 14, just to review some of the key items, Parker's balance sheet remains solid. The cash on the balance sheet at quarter end was $190 million. The commercial paper outstanding was $166 million. This is down $189 million from last quarter. Inventory was reduced another $18 million this quarter. However, currency added $30 million, resulting in a net increase of $12 million. Accounts receivable in terms of DSOs, 54, up 1 day from the same quarter a year ago. That is offset by the fact that weighted average days payable outstanding increased 4 days in the quarter. Probably should mention this, although albeit minor, there was a reclassification that took place in this quarter. Accounting requirements required that liabilities for minority interest -- those have been moved to a new equity account called noncontrolling interest on the balance sheet. This was only $477,000, so, again, as I said, minor. And on the income statement what was booked as other expense is now booked below net income. So I thought I would just point that out. However, it is relatively minor.

Moving to cash flow on slide 15, operating cash flow for the quarter was $260 million, and this represents 11.6% of sales. Of the $260 million in cash flow for the year, $30 million was utilized in connection with CapEx. That represents 1.3% of sales. $45 million was returned to the shareholders through share repurchases of $5 million and payment of dividends of $40 million, and debt was reduced as I said earlier by $162 million in the quarter. There were no acquisitions that closed in the quarter.

And on slide 16, you can see that the debt to total cap ratio was down to 32.5%, and on a net basis, 30.5%. So good improvement in that.

Moving to guidance, slide 17, the guidance is shown on several slides, 17 through 19. On slide 17, the guidance for sales and operating margin by segment has been provided, and on slide 18, the 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 this slide, the guidance for fiscal year 2010 for earnings per share was projected to be $1.55 to $2.05, up from $1.25 to $1.75. Please remember that this forecast excludes any acquisitions that may be made in fiscal year 2010. The full year revised guidance assumes the following. Decreased revenue approximating minus 8.1% to minus 11.8% -- and this is an improvement from previous guidance of minus 8.7% to minus 12.5%. Segment operating margins as a percent of sales in the range of 8.1% to 8.5% -- and again, this is an improvement from 7.2% to 7.6%. We chose to present the guidance a little differently in terms of below the line items. We've given you the midpoint. As you can see, corporate and administrative costs are assumed at the midpoint to be $147 million, interest expense is assumed to be at the midpoint $108 million, and other expense income is assumed to be at the midpoint, $100 million. If you total those below the line items, it comes to $355 million, and our forecast assumes that that could be in the plus or minus 7% range. The tax rate remains at 30%, consistent with previous guidance.

And let me just make a couple of points with respect to guidance compared to the previous guidance, before I open this up here. First half sales have been increased to take into account the better first quarter. Second quarter sales are lower by a minor amount, as we think some sales have been pulled into the first quarter. The second half sales have been tempered, but by a very minor amount. And with that in mind, however, a recovery has been built into the second half. Segment operating profits have been increased to reflect the better first quarter and the cost cutting initiatives. And of course, below the line items have been adjusted to basically reflect the run rate of the first quarter. To provide a little more clarity on the guidance for the year, the split in terms of sales, first half, second half, are 48% and 52%. The earnings per share is a little more heavily weighted to the second half. And in the near term for the second quarter, we think that you have it right in terms of EPS.

At this time, we'll now commence with the question-and-answer session. So if you want to open up the call, Shanika, I'd appreciate it.

Thank you. (Operator Instructions). Your first question comes from the line of Joel Tiss of Buckingham Research. Please proceed.

Wow. I'm shocked. I'm first. How you doing, guys? Two things, fast. Europe, can you talk about if you're seeing improvement there at a faster rate than what you're seeing in the US? And also, in the climate industrial controls, can you talk about any other end markets that you're seeing improvement besides automotive?

Well, Joel, just to answer the first part of your question, and then I'll let someone else jump in. One of the things that we are seeing in terms of the international orders is that they are increasing at a higher rate than what you're seeing in some of the other places. Okay? Now, in terms of Western Europe, we think that's still pretty soft -- but international in total, and you're going to see that reflected in the guidance, because obviously Asia-Pacific and Latin America are doing quite well.

As far as the -- Joel, this is Don. As far as the CIC, I believe that was the second part of your question, the CIC Group -- The refrigeration is pretty flat overall is what we're seeing right now. I think the Clunkers program brought forward some business, represented about $16 million in business for us, additional business from the clunkers that will basically fade away. I think we're stealing from future periods with that. And then the heavy duty truck, I would say that what we've seen here of late is some uptick on our [312 pressure curves] on heavy duty trucks, so we think that there's going to be a slight improvement in heavy duty trucks. So if you look at that three segment, those three would make up the majority of the CIC business. And so it's a little bit of a mixed bag, but that's how we would see it.

Okay. Perfect.

Thanks, Joe.

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

Good morning everyone. Nice quarter.

Good morning, Eli.

As I look at the comparison of the guidance today versus the end of the year, I mean, the only place you have better sales is international or less of a decline. The other ones tweaked up. What's noticeable is the profitability of every segment has been improved to some degree, particularly international, [6.7 to 6.2]. I think it was [44.6] the last time, and CIC. Can you tell us what's going on? Is that just the cost controls and better pricing, or what's driving what are generally better profitability on probably same or little bit lower sales internationally?

Eli, this is Tim. I think it definitely is due to the realignment work we undertook last year. We told you that last call that we had accumulated about $52 million in realignment costs all-in, and felt that that would generate $80 million in savings on an annualized basis. And, in fact, that has occurred. It may be a little bit plus. So the biggest part of it is just that, and so we're very pleased with that. That came through more quickly than we had realized, although I think as you know, we have some more restructuring ahead of us in this year as well.

And is pricing doing -- holding up pretty well? I see there's a little bit of attempt to increase prices, particularly on an MRO basis. Is that holding? Do you have some idea what's going on?

I think it's important for everyone on the call to understand how we manage out here. It is decentralized environment. We have about 135 business units, divisions. Every one of those units under the Win strategy have an obligation to know their sales price index and they also know their procurement price index. And it is their job from down there to manage those two and obviously try to stay on the plus side. So there has been -- it's been a crazy ride over the last 18 months and things going -- materials going up and down and what -- the object here always is is to try to stay equal to or slightly to the positive, Eli. So it's -- I can't give you a corporate-wide answer, because it's across all of those business units. But I would say that our people, it appears, are doing a good job of that.

You're not seeing price weakness anywhere, or any problems in the marketplace because of the slack environment, pricing standpoint that you know of?

No, we've had pressures. Mostly the pressures have come on decreases in raw material. Those are a real thing. You have to be sensitive and adjust to that. The key is to of course not make an adjustment that's greater than what you're seeing on your procurement side. So that's it. I think it has -- what has not occurred is people coming in and saying gee, my business is down 20%, and I need a big decrease because of that. We're down -- well, of course, we're down 20% or 30% and so that really -- I don't think we've heard a lot of that. It's mostly been tied into the materials.

Any LIFO profits in the quarter or anything like that?

I think LIFO is fairly benign this quarter here.

Thank you.

We had a little bit of a credit. That's right. I'm sorry. We had a little -- we did have a little bit of a credit that did occur when the raw material prices were going down at the beginning. Now we're seeing those raw material prices come back up, spike up back, and so I think that we did enjoy credit, that's right, this quarter. But it will probably go away next quarter.

Thank you.

Thank you.

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

Good morning, guys, this is actually Nicole asking questions on Nigel's behalf. A couple for you. First of all, looking at your guidance, looks like industrial international was the biggest delta on the revenue side. If you could talk about how the delta breaks out between FX and core?

In terms of the guidance, Nicole, we really don't have FX baked into that number.

Okay. So that's pretty much all organic?

We don't -- we can't predict what's going to happen there so our policy -- unless it just gets really out of line, then we may do something. But typically our policy is just not to try and predict what it will be.

Okay. Got it. And then looking at your MRO trends, how did that track each month of the quarter?

Well, I don't have each month of the quarter here, but I can tell you that definitely September we saw an uptick in most of our markets. And when you look at them, what happened is April, May and June,depending on the free-fall during that time period, it -- you have to look at that in terms of what's happening and then in the next quarter with things coming up. But definitely September was a pretty strong month.

This is Tim. If I could just add to that. Something that's interesting that has occurred. Traditionally in a severe downturn recessions in the past, we would see the uptick begin with the big, large mobile customers, big mobile OE customers, and at this stage we are not seeing that. What we're seeing are people who are definitely replenishing their shelves, having been closed down in the summer and running their inventories way down. And we're also seeing, which -- some good orders out of nontraditional markets for us where we have been working very diligently over the last few years to take our technologies and over the last few years to take our technologies into our nontraditional markets and frankly, some of the nice upticks we're seeing are in those markets.

That's really helpful. One more, if I may. What plant shutdowns have you guys -- are you guys anticipating for the second quarter for your customers?

Well, I mean, we think that there are going to be some shutdowns, just like there always are during that time of year. It really depends on which customers you're talking about. But we think that they will take the time to -- like we said, our forecast is a roll-up of all of our different divisions and so each one of those divisions have baked what they're seeing from their customers into that. So we don't take a view from that here at the corporate level in terms of saying hey, such and such customer's going to be down 10%, we're going to bake that in. But we do think that they'll take the opportunity. We really don't see orders picking up much until January. So -- and I think that's consistent with what we've been saying as we've been on the road, we've been talking to people, hey, we don't think that we're going to see much through the end of the calendar year.

Great. Thank you, guys.

Thank you.

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

Hi, good morning and congratulations. I guess two questions. One, I just want to clarify. Pam, I think you said in prepared remarks the second quarter numbers, [wherever] the Street is in the second quarter of about $0.30, that looks about right. Just trying to figure out why the second quarter would be worse than the first. I understand you had some pull forward, but I think you said that was only $16 million. And then I guess just my second question, just to dig deeper, again, on the international margins, I guess that really surprised me. And Tim, why would it -- why would we think margins are going down? Your guidance implies margins are going down in the back, in the remaining three months. I'm just trying to understand why, and at what point do you think international margins get at parity with US?

Well, let me answer your first question, okay? And that's you're talking about the second quarter.

Relative to the first, yes.

And then we can address the international margin. But we did $0.45 in the first quarter. We're going to have more restructuring. Tim talked about the restructuring I think last time on the call. We said hey, we're going to have about $40 million of restructuring and we're going to get about $40 million of benefits in the year. As he mentioned a little bit ago, the restructuring is going up. So we're going to have $0.04 additional restructuring in the second quarter versus the first.

Okay.

The other thing is we had a LIFO gain. We had a LIFO gain in the first quarter, and plus we really were helped on some of our benefit plans by the market. The markets performed well and that created a little benefit for us in terms of some benefit plans, which -- those two combined is about $0.06.

Okay.

And then we have a little bit lower sales projected in the third quarter. So if you take -- that's about $0.03. So you take that $0.13 out of the $0.45 and that gets you pretty close to --

Got you. Okay. And then just Tim, on the international front, because that really surprised me and I -- doesn't appear that there's anything unusual in there, but why would that be going down with your international sales forecast getting better? Especially when you think about international, I mean -- Europe in your first quarter I would assume you had a lot of shutdowns, et cetera, so I'm just trying to understand, I guess.

Sure. No. But actually, Pam really just answered that in the fact that as is obvious, our biggest problem on the down side on marginals that have been higher on the negative side than we wanted was on the international front.

Okay.

And so as -- we needed -- we realize we need to do more work within material, particularly in Europe. As I say, Asia and Latin America are doing better and are rebounding well. So we need to do more in Europe, and so this additional restructuring that we're talking about and what has been added since the beginning of the year is in Europe. So you have a couple phenomena. There were -- as Pam said, there was some restructuring that didn't get done in the first quarter that now has shifted into the second, plus there's going to be additional restructuring on top of that. And that is why it looks the way it does, Jamie.

But are you more optimistic? I think last time I spoke to you, you thought US and international margins would be more at parity in 2011. I mean, is that still the way you're thinking about it?

Yes, I think so. We got to get through 2010. We've got more hard work to do. There is not much more restructure, realignment occurring in North America, I'm pleased to say. Most of it's over there. But we have that work to do. It takes a while. And so I think there's going to be a fair amount of noise, if you will, in 2010. But by 2011, we should be comparable, yes.

Thanks, congratulations.

Thanks, Jamie.

Your next question comes from the line of Andy Casey of Wells Fargo Securities. Please proceed.

Good morning, Andy.

Good morning Pam. Good morning, everybody. First, a question, if you could give a little more color, I know you've -- Tim, you talked about large mobile customers not picking up like you would see in typical cyclical upturns. Is there any further color you can give by market, product space, to help us understand what's going on?

Andy, this is Don. Just going to give you a little rundown of what we think is looking positive and what's looking maybe flat to negative at the current time. Just some market segments. Life sciences, we've seen a positive uptick in those markets. I think you probably are aware of the semicon market coming back. That's been a positive for us of late. The process industries as well, chemical process and refineries and so forth. We've seen a little bit of an uptick there.

Heavy duty trucking, I'm going to be talking about 312 pressure now, not specific markets after this next one, just heavy duty trucking on a 312 basis we've seen an little uptick in that. But in general, the good news I would say on the positive side is that when you look at all of the regions around the world, and we look at -- we have maybe 30 different pressure curves we look at here. Industrial North America, and Europe, we've seen a little uptick on the 312 pressure curves. That bodes well. That's the first time we've seen that in a long time and it looks like it's going to be sustainable and that would help as far as supporting our second half forecast. The Asia and Latin America pressure curves, the 312 curves, I would say are better than a little uptick. I would say they're more like a modest uptick in both of those regions.

So I think when you look around the world, it's a pretty decent picture, although at the early days. We're still early days here. But I think it bodes well for the future here, based on what we're seeing on these pressure curves. Housing starts, the 312 is up modestly. Of course, we're not going to get back to the 2 million homes a year any time soon, but at least it's up from the rate -- the run rate that we've been running at. You all know on the call that the ISM Index is above 50%, so that bodes well. That seems to be consistent with what we're seeing on these pressure curves.

Now, on the flat to negative side, we can just talk about the Aerospace first -- the passenger revenue miles are down about 21%. Commercial OEM, commercial aftermarket are actually trending down a little bit, as Pam indicated earlier. On the military side, the military OE is still looking okay and the aftermarket is still good as well. So it's a little bit of a mixed bag there. When I say commercial OEM, I'm going to include the regional aircraft as well as the business aircraft in those numbers. Just a little bit more then -- the offhighway construction is pretty flat. I would say that it's fairly dead. Refrigeration, as I indicated earlier in the call, and ag is pretty flat. Our distribution, interesting at this point in the cycle, is relatively flat as well. I would expect that to start coming back here in the near term.

And I guess just as a general statement, I would personally not expect any significant recovery until the job losses stop. I'm not saying that the jobs recover, but we have to see job losses stopped. Every month we're seeing more job losses. Even though these numbers are good, I think they could be a lot better if we could put a stop to the actual losses. Of course, it's going to be some time before we see job pickup, because there are a lot of companies, including ourself, that are on short workweeks. So we're going to have to absorb all the short workweek hours before we start hiring new people. So hopefully that gives you an overview look around the world in some specific markets as to how we're looking.

It does. Thank you, Don. One additional quick question, I guess. In the quarter, the Aerospace margins were better than I was looking for. Clearly, with the guidance you expect along with the commentary you just gave and Pam gave a little bit earlier, that those are going to come under pressure. Could you talk about commercial aftermarket trends? I mean, are they still going down and you expect them to flatten out sometime in the future? Or did they perform a little bit better in the quarter than you would have expected?

Andy, this is Pam. Let me just address a couple things and other people can jump in here. But on the Aerospace side, one of the things that did occur in this quarter, because as you see the margins are a little bit better than what we anticipated, is we really -- the timing of the R&D is very difficult for us to project. And so we actually had a little less R&D in that first quarter -- not that we think we're not going to incur that R&D. We are going to incur it. It's just -- it did help this quarter. I think that's important to recognize. The other thing is on the commercial aftermarket side of the business in terms of spares airlines, they're just -- they're not willing to spend money, just like everyone else right now. So they are not buying spares and we had said that the commercial aftermarket would be down in the range of 9%. But then we said that that would be offset because in the second half, we had retrofit programs that were going to kick in.

So that's how that lays down. We still think that commercial aftermarket is going to be weak. We think that it's going to come back longer term. It's going to be weak for a time period, but we think with the revenue passenger miles ticking up. And I think the airline industry in general, at least everything I've seen and I was just at an Aerospace conference, is that in fact, I don't think the industry's going to suffer the downturn that they originally thought. Not to say that we're not going to see some weakness there, but I don't think the weakness is going to be as great as we originally thought in the commercial aftermarket.

We did see an uptick in the military aftermarket side of the business, particularly in September. That's when obviously these programs start to end, the budgeting comes to an end and people are trying to spend money, so we did see an uptick on the aftermarket side of that. We don't think commercial aftermarket is going to be like I said as bad as originally thought, but we do think it's probably going to be around 4% or 5% down for us for the year, and then hopefully coming back up after that.

Thank you very much.

Thank you.

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

Good morning, Ann.

Good morning, guys. How are you?

Good, how are you?

Doing good. Could you guys talk a little bit about of all the restructuring you're doing and the incremental restructuring that you're undertaking, how much of the cost reductions do you anticipate will be permanent versus semipermanent, as we think about consolidating some of the back office functions as being maybe more semipermanent and costs creep back in over time? Can you just talk a little bit about how you're approaching the restructuring in terms of permanent cost reductions versus semipermanent?

Ann, this is Tim. I think that permanent's a long time. But as we told you, the $52 million hit we took last year to generate $80 million savings, which we would construe to be permanent. And that's occurring and that's flowing through. We are now -- the $60 million that is now in the plan versus the $40 million we started with, we also feel will be dollar for dollar payback. We may not get it quite all this year. We hope to get as much as we can. And we would view many of those as permanent also. These are not just the simple force reductions. These are more permanent realignment, restructuring. And now, can I say they're really permanent forever, well, that's another question. But I think we would expect that to flow through.

Could you give us some examples of what you mean by they're not just [rips], they're consolidations -- is it things like consolidating back office or consolidating engineering? Some sense of what these projects really are like? It's hard for me to consider anything permanent unless it's shutting down a factory and closing out the lights.

Well, you just hit on it, Ann. This is Don Washkewicz. The last year, we have closed down 25 facilities around the world, and looking into this year, we're working on closing down another 25. So you're talking about 50. I think when Tim mentioned that, what's permanent, well, some of that we've consolidated in other areas. But the overhead cost portion of the actual shutdown is permanent, because we're not bringing those facilities back online. So that's the most permanent part of what we're doing here. Of course, there's always other cutbacks that we're making and other -- both in the SG&A area throughout the organization, and if activity ramps back up, some of that cost is going to come back in. But it will be coming in proportionate to our activity pickup. So that's the way I would characterize the restructuring.

That's great color. That's exactly what I was looking for, to get those facilities out, the lights never come back on.

Right.

And then just to follow up on that and not to belabor it, but the fewer work hours, the furloughs, et cetera, all the way up and down the food chain within the organization, when do those costs start to creep back in?

Well, the best time for those to creep back in -- first of all, nothing is going to creep back in as far as -- we have a wage freeze going on right now. We have a 10% hour reduction as far as work hours reduction for the salary team, pretty much worldwide. That will go on throughout the calendar year, the balance of the calendar year. We're going to re-evaluate what we want to do after that and it will be based on the activity levels.

I think the best way to depict when people would start coming back to full hours is when the demand justifies it. When the demand picks up and it justifies filling those ranks with full hour work weeks, then we'll do that. Because what we did is we did the hours, the hour cutbacks to basically save jobs. We took a 20% reduction in workforce, and then we needed another 10% reduction, but we were getting pretty deep in the organization. We wanted to have someone there available to come back on when things turned around. So what we did was we -- instead of cutting another 10%, we decided to take a 10% hour reduction. And I think that was the right thing to do, because as things turn around here, we're going to need those people for the turnaround. So -- but those will come back as the demand picks up.

That will probably vary business by business, unit by you unit, function by function?

Exactly. But it won't happen this calendar year. It will be next year.

Okay. And then just finally, one quick point of clarification. Pam, normally you guys set your FX exchange rates before the beginning of the fiscal year. I think traditionally it's been around March to April timeframe. When did you actually set your FX levels for this fiscal year?

March 1st.

March 1st.

Yes.

Okay. That's the number we should use.

We've been doing that for years and years, and that becomes the so-called Parker rate that we operate to.

Yes. I did remember that. I just wondered with this year being so unusual across many fronts, it might have changed.

No.

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

Thanks, Ann.

You have a question from the line of Henry Kirn of UBS. Please proceed.

Good morning, guys.

Hi, Henry.

I guess first, could you talk a little about where we are in the restocking phase of the cycle across your end market base? Is there any way to characterize it?

Henry, this is Tim. I think that -- I don't want to mislead you because I don't think people are piling inventory back onto the shelves. I think that when we get orders now, and fortunately we are starting to get some now, it seems like everyone wants those to be shipped tomorrow. And I think they're going right out their back door as soon as they're done with it. So again, there's always a certain amount of safety stock that you carry that got run down or you just need on the line to refill the pipeline. And so I think that's the little bit of a surge in demand we saw in September, but it's not where people are laying in inventory.

That's fair. And on the financial health of your customer base, have you seen their ability to pay get better as we've progressed through the last six months?

I tell you, this is Tim again. I would say that the -- one thing that's impressed me through this downturn and being -- this is my seventh recession.

Congratulations.

Or condolences. I was always kidding. I was hoping I would retire before number seven hit, but I didn't make it. I am totally impressed with how well people have come through this, in terms of our distributors. We've had more distributor failures in years gone by than we did this time. I think that's because we indoctrinated them into lean enterprise as well. Likewise with the large OEs, I think that a lot of these companies, and you follow them, I think their balance sheets were in pretty good shape and people had learned some lessons and so not bad. On the automotive we had to suffer through some issues with the big auto guys, but in the end, it appears that we recouped -- Pam, I don't know -- ?

90%.

90% of that.

Well over 90%.

All in all, it's pretty good. Now, the concern is this. The concern is that companies like Parker and the other big names that you follow, probably in pretty good shape and they can borrow all the money they need if they need to. The problem is the smaller guys, the smaller customers, smaller distributors, where maybe their credit lines have not become quite as available to them. So that is something that we'll be watching and it's necessary to really turn this thing around, but not a lot of failures.

That's helpful. Thanks a lot.

Thank you, Henry.

You have a question from the line of David Raso of ISI. Please proceed.

Hi, good morning.

Good morning, David.

Hi. You don't usually provide quarterly guidance, but I just want to get a better feel for how the quarters are playing out relative to your expectations. For the quarter just reported, if you strip out the LIFO gains and other costs helped by the stock market returns, you did $0.39. Maybe you can quantify exactly some of the sales pull forward, what did that add? In general, how did the quarter play out versus your internal expectations?

You're talking about the quarter just ended?

Correct.

Well, obviously, I mean, the biggest portion of the gain that you're seeing, because when we were talking about the LIFO and the market adjustment and additional restructurings, we were really comparing first quarter actual to second quarter guidance. But if you look at the first quarter in comparison to what we initially thought, I mean, all segments came in much better profitability-wise. Again, I think this gets back to the excellent execution in terms of the cost initiatives that we've talked about.

When you look at the below the line items, they're really fairly benign. There was $0.05 corporate SG&A. We did get some help on the corporate SG&A line from the market as well, that particular issue. But then we lost $0.02 on other and we lost some on tax. You saw that the tax rate was higher in the quarter, and that was because of those adjustments that we took as far as the tax audits go. But really, I mean, the clear performance versus what -- the expectations is clearly above the line. Segment operating income, it was across all segments of the business.

Just want to quantify -- of the $0.30 increase in the full year guidance, how much did you just get? Did you just get $0.20 already?

Yes. And we've got the $0.20, but we've added $0.40 to the segment operating income for the full year guidance.

Okay. But talking straight EPS, just trying to think through -- internally you obviously have your own quarters played out, you just got $0.20. You raised the full year midpoint $1.50 to $1.80. Essentially the rest of the year just went up $0.10. The next question is, the core sales growth for the company, again, thinking through the quarters -- when do you expect the core sales growth for the company, year-over-year, to turn positive? Maybe even want to give a little color between North America and international for the industrial business?

We're looking -- David, this is Tim. We're looking for that to start to occur at the end of this quarter. But again, a year ago we started this quarter very strongly and then of course the world came to an end. Our orders held up for a while in different markets. So I think that the real year-over-year plus we're going to see will start -- will be in the next quarter, the first calendar quarter. And then we had assumed that that would occur and that it would accelerate a little bit, we're not talking about a steep V, but a very modest U or something into the fourth quarter. So the indices all fell way off in the middle of this quarter, and so it depends on if you see it day-to-day or week to week. But that's how we see it playing out. And that was built into the plan, as you know, all along. We had an upswing in the second half.

And lastly, I believe I heard Don correctly. The incremental margins in the fiscal second half, 45% on a business segment basis, is that as you planned as well?

Pretty much, yes.

Okay. Terrific.

Pretty much. David, let me I guess say this right now, to weigh in a little bit of what we're giving you here and how we're planning. We've talked a lot about that. We are planning cautiously, I guess if that's the right word. We haven't -- we've seen a little bit of improvement here and there. We're not sure if it's sustainable. So we're pretty much hanging where we were, and we did have a bit of an uptick getting into the tail end of our second half. We're not changing anything on this, because until we have it in hand, there's no sense in increasing budgets or anything. We have more hard work to do and realignment and getting this company to where we want it to. So as I say, if it looks as if we're being cautious or conservative, I hope that turns out to be true. We think it's prudent to stay at this level in running the company.

One last example would be any change in sentiment internally, how is your pricing strategy for January 1 changed at in the last three months?

David, this is Don. I don't think it's changed at all. I think we have some people going out for price increases. Everyone, again, per what Tim said, is looking at it individually based on what their raw materials are doing and so there are some increases in the works. I would say there's nothing dramatic, if you would, going out. But they will be reviewing those in January and then again in June like we do every year.

That price cost relationship is all baked into -- you're still at 45% incrementals.

That's correct. That's all in.

Thank you for the time.

Thank you, David.

You have a question from the line of Alex Blanton of Ingalls. Please proceed.

Good morning, Alex.

It's Ingalls and Snyder. Just quickly, because we've got to get off here and get on another call, but you said, Pam, that the $0.45 for the first quarter was above your guidance. But you didn't give any guidance. So what did you mean by that?

That is very true. We gave first half, second half. You're exactly right. Obviously, internally we do model just like everybody else does, so we have our quarters broken out. We don't supply that, but you're exactly right, Alex. Thank you for calling me on that.

So were you talking above your own internal expectations?

I was. Thank you for that clarification.

Secondly, the 45% incremental margin for the second half that David Raso just mentioned and that Don mentioned earlier -- that's very, very high. What are the main contribute -- drivers of that? I mean, that's a very high incremental margin for any business.

Alex, this is Don. At the early stages of a recovery, you expect to see, number one, higher incrementals. Number two, a lot of what we had started this past year, the restructuring that we started, was going to carry over and we were going to see the benefits this year, which will be -- a lot of that will come in the second half of this year. And again, some of the restructuring we're doing right now is going to improve the second half as well. So I think if you look historically, you will see that in the early stages of a recovery, we're going to hit some pretty high incrementals. And we're not planning on bringing or starting a big hiring program around here either in those early phases. So I think these are sustainable. I think these are realistic.

So it's a restructuring benefit.

I just want to clarify, that 45% is on the segment operating margin line, just so --

But still, I mean, that's pretty high even for a gross margin.

I just want to make sure everybody was on the same page with respect to that.

Thank you very much.

Thank you.

You have a question from the line of Jeffrey Hammond of KeyBanc. Please proceed.

Hi. Good morning.

Good morning, Jeffrey.

Don, you expressed still some conservatism regarding the acquisition pipeline and outlook and you still seem to be in hunker down mode, yet we're seeing some signs of bottoming and turning a corner. What do you need to see to really change your tact on acquisitions?

Well, the whole approach, our approach right now has been really to manage for cash, and in so doing, what we're really trying to do is to pay down as much debt as we can. As you know, at the beginning of last fiscal year, we acquired about $0.5 billion worth of sales and ran our short-term debt up, commercial paper and so forth. We're working that back down, trying to get that back into better shape. We're down in the low 30s now which is nice territory, and I think we'll drive it down below that. If in fact our forecast holds true, we're going to be in very nice shape. But we're going to be cautious at the early phases of the cycle. We're going to be looking.

Basically what we're doing now is trying to make sure that we have those contacts in sight, the ones that we want to pursue, and make sure that we're developing those relationships so that when we are ready to move forward, that we do so and take advantage of some of the opportunities out there. But I would say don't expect anything this half of the year, okay, and look -- let's look into next half and probably more in the tail end of the second half before we would really start getting serious about doing anything. Again, our main objective right now is maintaining those debt ratings, maintaining a strong balance sheet, getting ourself in the position to really take advantage of the turnaround. But we're still a little bit early here in the cycle to get aggressive.

Okay. And then just not to spend too much time on FX, but if I look back at March 1st, the Euro was $1.26. Now it's -- versus $1.49. Just to clarify, you're still using that $1.26 in your guidance, or you've adjusted up to the more current rates?

We just -- I think we had, what, it was $46 million or something like that in terms of impact on sales from currency, $46 million. We didn't forecast that in. We forecast zero. So we don't try to project what the impact on the sale's going to be as a result of the FX.

Okay. But you acknowledge if the Euro stays at $1.49, you're going to have a big FX tailwind?

We do.

The guidance going forward incorporates where we are today, does not incorporate where it might go to.

Okay. Great. Thanks.

Thank you.

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

Good morning, everybody.

Hi, Rob.

I was wondering if we could get just some clarification on this discussion of restructuring costs. You had $19 million in the first quarter. We've gone from a budget of $40 million this year to $60 million. Could you talk about how that's going to break out over the balance of the year and can you split the $19 million for us among the segments? Or is that all in international?

Well, I can just give you a little bit of flavor. In terms of the $60 million costs, it's definitely front end loaded.

Meaning you'll be done after this coming quarter?

No, we'll still have some in the second half, but it's definitely front end loaded. There's much more in the -- I don't know what the breakdown of it is, but --

But I think roughly, EPS basis, Rob, I think you had about $20 million this quarter. It will probably be more like $30 million next quarter. There could be another $10 million that goes into the third quarter, and then we would be done with it.

Okay. And then Tim, can you help us similarly with the benefits? The $80 million plus that you got last year was a benefit realized during the year or run rate? Remind me.

That was the run rate. No, we -- in fact, the savings last year I think was -- and I can't remember. It was about $40 million. It was less than the $52 million. It was $45 million, maybe.

Okay.

So there is a lag factor, Rob.

Oh, of course. So you carry another $40 million ish into this year, and then your thinking is that you're going to get as much as half of the $60 million also during this year?

I'd have to go do the math, but I'd say at least half, if not more.

Okay. So round numbers, $75 million of benefit expected this year, and then you would carry whatever is left to the following year?

Right.

Okay. Very good. And can you give us a little help with the segmentation? Was it all international?

I think it's best -- that's a lot of detail. I'm not sure if we have it all. I think we'll have to figure out how to do that offline for those who need that information.

Okay. That's good. Thanks, Tim and Pam.

Thank you. Thank you.

There are no further questions. I would like to now turn the call over to Ms. Pam Huggins. Please proceed.

At this time, we're going to turn it over to Don, who just has a few closing comments, and then we'll complete the call. Thank you.

Okay. So as we stated, for now we are just going to continue to focus on maintaining a strong balance sheet, managing for cash, and maintaining our cost levels at a level that's consistent with reduced demand. Our plan is also paying increasing annual dividends. We didn't talk about dividends, but we do plan to pay increasing annual dividends for the foreseeable future. We feel that Parker is poised to emerge from this recession far stronger than we've ever been before.

Once again, I want to thank everyone on the call for their participation. We certainly appreciate your interest in Parker, and I want to thank all of our employees who work so hard to deliver these results. Pam will be available the rest of the day if you have any further questions. Feel free to give her a call. And so with that, good-bye and have a great day.

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