派克漢尼汾 (PH) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Parker Hannifin Corporation second quarter 2010 earnings conference call. My name is Amica and I will be your operator for today. At this time, all participants are in listen-only mode. We will have a question-and-answer session towards the end of the conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. At this time, I would now like to turn the call over to Pam Huggins, Vice President and Treasurer. Please proceed.

Thanks, Amica. Good morning everyone. It's Pam Huggins speaking. I hope we get through this call today. We just had a power outage here, a general power outage, not Parker specifically, so we're hoping we make it through the call. I would like to welcome you to Parker Hannifin's second quarter fiscal year 2010 earnings release teleconference and joining me today is Chairman, President and Chief Executive Officer, Don Washkewicz, and Executive Vice President and Chief Financial Officer, Tim Pistell.

As usual, let me just address a couple of administrative matters prior to beginning with actual earnings release. First, for those of you online, you may 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 IR 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 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, up indicates that in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers.

Moving to the agenda on slide number four, the call will be in four parts today. First, Don Washkewicz, Chairman, President and Chief Executive Officer, will provide highlights on the quarter. Second, I'll provide a review including key performance measures of the second quarter, concluding with the revised outlook for fiscal year 2010. The third part of the call will consist of our standard Q&A session. And for the fourth part of the call today, Don will close with some final comments.

At this time, I'll turn it over to Don and ask that you refer to slide number five, titled second quarter fiscal year 2010 highlights.

Thank you, Pam and welcome to everyone on the call. I want to start with just a few highlights for the quarter. First, our results in the second quarter demonstrate that the actions taken over the past year to restructure our operations in response to the severe recession are certainly paying off.

While our comparisons to the prior year are still negative, comparing our performance to the first quarter of this fiscal year shows significant improvements across many measures. In particular, our margin performance this quarter and our cash flows are very strong. On the demand side, we're beginning to see signs that we will -- that we believe to be a recovery in the end market demand. We are monitoring orders across all of our markets and are proceeding cautiously. Early indications are that the early signs of a recovery are coming from multiple regions and a range of markets and I'll give you a little bit of color on that a little later in the call. These are certainly good indications for future growth.

Our near term objectives remain the same as they have been during calendar year 2009. We want to continue to manage for cash as we have been, maintain a strong balance sheet, we want to target a 30% MROS or incremental on the upside or down side, and a 10% operating margin. And then of course we want to prepare for future growth. I am pleased to report that we are exceeding our objectives.

We generated $346 million in operating cash flow in the quarter, or 14.7% of sales. For the first six months, we are at 13.2%, both of these are well above our 10% target. For the past 12 months, we have been able to reduce inventory by $336 million. Our intention is to continue to maintain a strong balance sheet. In the past year, we have reduced outstanding debt levels by $1 billion. That brings our commercial paper down to about zero right now. zero right now and our debt-to-debt equity ratio below 30% at the end of the second quarter. These actions are helping us maintain of course our strong credit ratings and balance sheet.

I'm also pleased that we were able to generate segment operating margins of 10.4%, exceeding our four year goal of 10% and equalling our margin performance in the same quarter a year ago. Our decremental margin return on sales, MROS in the quarter was an impressive 10.6%, which far exceeded our target of 30%. And that's on the down side, of course. Parker employees throughout the world have responded remarkably to this downturn and importantly have positioned us very well to benefit fully from the recovery as it develops.

In our markets, we continue to see somewhat of a mixed picture, but generally we are witnessing improving trends. Although order comparisons are easing, we are encouraged that order trends have improved sequentially for the past two consecutive quarters, indicating that the worst is behind us. Regardless, 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 position to benefit from the recovery.

Reflecting the benefits of our restructuring actions and improving market conditions, we are increasing our guidance for fiscal 2010 to the range of $2.40 to $2.80 per diluted share. Our previous range was $1.55 to $2.05 and that's a midpoint of about $1.80 and this represents a 44% increase on that midpoint. I might also draw your attention to the fact that when we started this fiscal year, we started at a guidance of $1.50, at midpoint, and our current guidance now represents a 73% increase from that starting point.

So with that, I'll turn it back over to Pam.

Thanks, Don. For more detail on the quarter, reference slide number six and I'll begin by addressing earnings per share for the quarter, consistent with what you saw in the press release this morning, earnings per share came in at $0.64, and this compares to $0.96 for the same quarter a year ago. Included in the $0.64 is $0.03 in realignment charges for the quarter and the $0.64 in earnings per share for the quarter exceeds the guidance provided last quarter, due to higher sales in all segments of the business, other than Aerospace, and higher operating profits across all segments other than Aerospace. However, it should be noted that Aerospace met the guidance on sales and operating profits for the quarter.

SG&A expenses were lower as a result of the execution of a strong budgetary control environment, including lower incentive compensation, and all of these were offset by higher other expense due to benefit plans, FX and asset write-offs. Also had higher tax expense, due to higher income, but a slightly lower tax rate. Decremental margin return on sales was a respectable 11% for the quarter. And as a reminder, this is the difference in segment operating profit divided by change in revenue for the quarter on a year-over-year basis.

Moving to slide number seven, and 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, let me just run through the puts and takes for you. A 12% decrease in revenues in the quarter, revenues were lower versus last year in all segments. On a sequential basis, sales were higher in North America and international. As a result of the lower sales versus last year, operating income was lower in international and Aerospace only. North America and Climate & Industrial Controls, even with lower sales posted higher operating income. Again, this favorable outcome is obviously the result of the realignment and cost controls put in place last year and this year as well.

Realignment expenses were fairly comparable year-over-year at $7 million. $4 million net of tax or $0.03 this year, and that compares to $9 million, $6 million net of tax or $0.04 for the same quarter a year ago. Selling, general and administrative expenses declined $27 million, again, due to tight budgetary control and lower incentive compensation. Interest was lower by $5 million, due to less outstanding debt. And higher other expense, and again, this is on a consolidated basis, of $8 million was mainly due to asset write-offs and pension expense. Lower tax expense of $5 million, again, due to less income, but the tax rate was slightly higher due to normalized tax R&D credits, and more shares outstanding impacted earnings by $0.01.

So moving to slide number eight, and looking at the top line, revenues for the quarter, decreased 12% to $2.4 billion, from $2.7 billion last year. Of the 12% decline in revenues, acquisitions had no impact. Currency translation increased revenues by 4%, and the currency impact was mostly due to the International Industrial segment, mainly the Euro against the dollar and the organic or core decline in revenues was 16%.

Now, moving to slide number nine and focusing on segments, starting with Industrial North America, North American revenues declined 15% in the quarter, versus the same quarter a year ago. The majority of the decline was base revenues as acquisitions didn't impact revenues this quarter, and currency translation was favorable, increasing revenues by 1%. The net result as you've seen was the base revenue decline of 16%. In spite of the decline in revenues for the quarter versus the same quarter a year ago, operating income was positive and actually increased 6%, resulting in a favorable marginal return on sales.

Operating margins were 270 basis points above the same quarter last year. And operating margins increased sequentially from 9.7% in the first quarter, to 13.5% this quarter. So continuing with the Industrial segment, moving to International, revenues declined 11% in the quarter versus the same quarter a year ago. Currency translation was an addition to revenues in the quarter of 8% and this is versus a deduction of 3% in the first quarter. Acquisitions had no impact on revenues and the net result was a base revenue decline of 19% for the quarter.

Second quarter decremental marginal return on sales was 29%, and this includes the effects of acquisitions, realignment charges and inventory reductions. Operating margins increased to 8.9% in the quarter, from 7.3% last quarter. Now focusing on Aerospace segment, Aerospace revenues declined 15% in the quarter versus the same quarter a year ago. Margins decreased 250 basis points from the first quarter, but as expected, and in line with the projection, and what was discussed on the last call. Revenues declined as a result of commercial business, mainly regional and business jets, general aviation, as well as spare parts in the aftermarket.

Now moving to slide number 12, the Climate & Industrial Controls segment, as mentioned, I think on every call, softness in North American automotive, heavy duty truck and residential air conditioning does affect this segment. Base revenues declined 5% for the quarter year-over-year. Currency translation was an addition to sales of 3%. The net result, sales were down 2%. Margins as a percent of sales were 3.5% for the quarter, versus a loss of 7.2% for the same quarter a year ago. And in spite of a decrease in sales, operating income increased, resulting in a favorable marginal return on sales for the quarter.

So at this time, moving to orders for the quarter, slide number 13. As you know, details orders by segment. These numbers represent a trailing three month average and are reported as a percentage increase of absolute dollars year-over-year excluding acquisitions and currency except for Aerospace. Aerospace is reported using a 12 month rolling average.

As you can see from this slide, orders are down 7% for the December quarter just ended. This compares to minus 25% last quarter, and minus 20% a year ago. North American orders for the quarter just ended declined 3% year-over-year, and this compares to minus 27% last quarter, and a minus 18% a year ago. So good improvement. Industrial International orders were flat year-over-year. And this compares to minus 25% last quarter and minus 28% a year ago. Aerospace orders are down 27% for the quarter, which compares to a negative 23% last quarter and a positive 2% a year ago. In the Climate & Industrial Controls segment, orders are up 6% for the quarter, up from negative 17% last quarter and a negative 28% a year ago.

Okay, now moving on to the balance sheet. Just to review a few items, Parker's balance sheet remains solid. The cash on the balance sheet at quarter end was $234 million. And as Don mentioned, no commercial paper was outstanding and this is down from $166 million last quarter. Inventory's been reduced by $336 million since last year. Currency, however, added $49 million, so the net decrease was $287 million. Accounts receivable in terms of days sales outstanding is 48, and this is down two days from the same quarter a year ago.

Weighted average days payable outstanding increased three days this fiscal year. So good working capital improvement, just moving to the operating cash flow for the quarter, was $346 million, and as Don mentioned earlier, represents 14.7% of sales. And of this $346 million, $31 million was utilized for capital expenditures in the quarter, 1.3% of sales. $45 million was returned to the shareholder through share repurchases of $5 million, and payment of dividends of $40 million and debt was reduced by $203 million this quarter. No acquisitions closed in the quarter. And on slide 16, you can see that the debt to total cap ratio is down to 29.9%, and on a net basis, 27.3%.

So now moving to guidance, fiscal year 2010 guidance, revised guidance. It's on slide 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 items below segment operating income. Slide 19 summarizes the guidance on an earnings per share basis. And as you can see from this slide, the guidance for fiscal year 2010 for earnings per share is projected to be $2.40 to $2.60, up from $1.55 to $2.05. $2.40 to $2.80, excuse me, $2.60 is the midpoint. Please remember that the forecast excludes any acquisitions that may be made in fiscal year 2010.

Now let me just talk about the guidance for a moment. The full year revised guidance assumes the following. Decreased revenue year-over-year of approximately 5 to 8%, and this is an improvement over previous guidance of a decline of 8 to 12%. Segment operating margins as a percent of sales, approximately 10% and this is an improvement over previous guidance of 8.3%. Corporate administration costs are assumed at the midpoint to be approximately $140 million. Interest expense is assumed at the midpoint to be approximately $100 million. And other expense is assumed at the midpoint to be $150 million. So if you take all those below the line items, they total to about $390 million, and we've given a range of plus or minus 3% on that.

The tax rate is projected at 29%. And just to clarify for you, and give you a little bit more color, third quarter revenue incorporates a 5% sequential increase over second quarter. And fourth quarter incorporates a 5% increase over third quarter. EPS for the quarter is approximately 10% over the EPS for the second quarter. And EPS for the fourth quarter, again, approximately 10% of the third quarter. Realignment costs will be higher in the third quarter versus the fourth, particularly in international. And below the line items have been adjusted to basically reflect the run rate of the first half. Just to clarify a little more, the split in terms of sales first half, second half, are 48%, 52%. And the earnings per share, again, more heavily weighted in fourth quarter versus the third quarter.

So at this time, we'll now commence with the question-and-answer session. And, you know, just as a reminder, the call will be limited to one hour, so please honor the request of one question and one follow-up should clarification be needed. By adhering to this courtesy, everyone will have a chance to participate. So at this time, we'll begin the Q&A session. Thank you.

Thank you. (Operator Instructions). Your first question comes from the line of Jamie Cook with Credit Suisse. Please proceed.

Hi, good morning and congratulations.

Thanks, Jamie. Good morning.

I guess my first question, not to beat a dead drum because I feel like you get this every quarter, but can you just sort of walk me through again margins on the international front were quite impressive. I know last quarter you were expecting more restructuring in Q2 relative to Q1, so how did that shake out relative to your expectations and then I think you said in your prepared remarks, Q3 will have more restructuring than Q4. I guess sort of what segments does that hit?

Yes. We can do that. Tim, do you want to take that or do you want me to take it?

Sure, that's fine. Jamie, hi. Tim. Unfortunately, once again in Europe, protracted discussion with works council could not get everything done that we wanted to get done in this quarter. So there is going to be about $17 million.

I think we initially had hoped -- we gave you $16 million in expense for the year to generate $60 million in savings. And we thought the cost would be roughly -- would be roughly $30 million, $30 million in the quarters and so forth. So then we -- it does appear, as I say, that we are now going to shift over from the second quarter into the third quarter, about $17 million. And the problem with that, along with that shift in the $17 million in costs from Q2 to Q3 is of course we can't start realizing the savings from doing that and so there's some of those savings will not all be captured in this fiscal year, and will be pushed out into next fiscal. So instead of realizing the full $60 million that we hoped for in this year, we'll probably only realize about 40.

Having said all that, we are proceeding. We will get it done. It will be done in this year. The benefits will accrue. And interesting, when you take a look at the analysis, I think with the updated projections that we've given you here today, quite interesting because you'll see that on volume we are projecting now volumes to be down $600 million, plus, this fiscal year versus the prior fiscal year. About $650 million.

And yet we're giving you a segment operating margin that's virtually the same. Now, in our math, that 660 or 650 would cost us close to $200 million in operating margin, and the reason we're coming in the same is we told you last year that we were going to generate substantial savings, $120 million in savings from those actions. The additional savings this year, what's causing that great marginal impact. So anyways, long-winded answer but trying to get all the numbers out there.

Okay. And then just last question, as a follow-up, first half is doing much better than I think I anticipated in total. Is there any price material cost benefit we get in the first half that we don't get in the second half, or any mix issues that I should be aware of, outside of you talked about restructuring, but any MRO versus OE, end market or geographical or material cost price, I'm just trying to think if there's anything unusual in the first half versus second half.

Yes, Jamie, this is Don. I would say don't factor in much in the way of any benefits from pricing as far as the earnings are concerned. What we're trying to do is try to maintain parity there. We're trying to make sure that whatever cost increase that we incur that we're promptly passing those on. So we've had some minor increases of late into the market and that reflects some raw material increases.

I would just give you a little color on raw material because you might find this interesting. Copper, for instance, is at a 16 month high. Aluminum's at a 14 month high. Zinc is at a 24 month high. So for zinc castings and things like that. Steel is going up.

So we're out there with increases today to basically cover cost increases, but not to expand margin, per se. So I think you're going to see those becoming pretty neutral. We hope to cover all the costs but I don't think it's going to benefit the margin at all.

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

Thanks, Jamie.

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

Yes, thanks, good morning.

Good morning, Nigel.

So just to maybe just the first question would be you could just give us a bit of of color on some of your major end markets and perhaps the mobile equipment markets lagged the Industrial markets in the last quarter, maybe you could just maybe make some comments on that, maybe in December and January.

Yes, Nigel, this is Don, and just maybe I'll kind of run you through some of the markets and some of the trends that we see. First of all, I think pretty clearly we're seeing that we're coming off the bottom and the bottom as far as we're concerned was the fourth quarter of 2009. So we're seeing continual improvement from that and gradual improvement. We think there's going to be gradual improvement from here going forward, obviously, based on the guidance we've given you.

Looking at regional, our regions around the world, kind of give you a little flavor for what we see there. The US we see recovering at a steady pace, nothing spectacular, but a steady pace. We would say Latin America would fall into that same situation, recovering at a steady pace. Asia is extremely strong, so it's coming back very strong. Europe is recovering slower, at a slower pace than either US or Latin America. So that's kind of how we see it regionally in the major regions around the world. For those on the call that are familiar with the ISM indices, I would just give you a little flavor for what we're seeing there.

The ISM for North America in November was 54, and in December was 56. So those are some pretty good numbers and it's the fifth consecutive month basically where we've seen growth in the manufacturing sector. So that bodes well. The new orders index was 66, and that's the highest number that they recorded since 2004. So that's another very, very good input. Inventories appear bottoming. We're seeing that throughout all of our end markets. Of course, that's going to create demand.

Europe's ISM is barely over 51. That's still positive and it's still a positive trend but it's certainly weaker than what we see in North America. Just a little bit about some of the countries in Europe, France and Germany look stronger right now. Italy and Spain, somewhat weaker growth. And the UK is fairly flat.

We've talked about our trends, our order trends that we monitor here pretty closely, what we call our 312 trends and our 1212 trends, and just thought I'd give you a little rundown as to what we see there. 312, would be the last three months orders over the prior year, the same three months. And the 12, 12, would be the last 12 months orders divided by the prior year's 12 or the prior period 12 months. So that would be what we call our 312 and 1212.

Industrial North America, we see gradually increasing in both of those metrics, in the 312 and the 1212. Europe, fairly slow increases but still positive in 312 and 1212. Asia is a very strong uptick in both the 312 and 1212. Latin America, very strong uptick. The interesting thing now as we're entering this part of the cycle and we're hoping to see this is that our distribution, we're starting to see life coming back out of our distribution channel, with stronger 312. And that's going to bode well for our 1212 going forward.

Heavy duty truck, the 312 was strong, somewhat erratic, and I think that had to do with the free buy situation, so it's still positive, but it's bounced around quite a bit, but still good. Refrigeration strong, 312. Semiconductor, extremely strong in both of those indices in both if 312 and the 1212. Process, strong, 312. Aerospace, flat, okay, that's the one that we would say is relatively flat right now is the Aerospace on both the 312 and the 1212 and that's pretty much indicated in the numbers that Pam has given you earlier.

Positive, now let's talk a little bit about sequential market trends from quarter-to-quarter, what we see going sequentially. Oil and gas, these would be some positive trends, positive markets out there. Oil and gas, power gen, alternative energy, marine, farm and ag, military aerospace aftermarket. Not the OEM but the aftermarket, positive. General industrial markets are positive. Cars and light trucks, semiconductor of course I already said was very strong.

Light construction equipment, not so much the heavy right now. and I think getting to your question, Nigel, I think it's going to be a little while yet before we see the heavy side of that coming back and of course that affects our hydraulics part of our business. but certainly on the light side we see some positive light there. I mentioned heavy trucks and then certainly distribution, so those would be the positive sequential market trends that we're seeing. The flat sequential trends would be life sciences. Some of these, however, keep in mind are at a fairly high level already. Life sciences, mining, is relatively flat.

Military, Aerospace, OEM, flat but at a pretty decent level. Residential air conditioning and refrigeration of course we know the situation with the housing market out there and machine tools, relatively flat. On a negative sequential basis, commercial Aerospace OEM and commercial Aerospace aftermarket, both negative trends, as Pam indicated earlier. And then the commercial air conditioning and refrigeration segments being negative trends.

The only other thing I would just mention here is that just to keep this in the back of your mind at Europe, when we talk about Europe, as we talk about Europe with our operating groups, Europe has had in many of the major customers over there have had major shutdowns, extended shutdowns, from the period of 12/18, December 18th, through in some cases through January 11th. So pretty extended shutdowns. That of course impacts our second quarter as well as somewhat our third quarter. So it will be interesting, as they come back in, to see what picks up going forward in Europe.

The only other thing that's going to be affecting us a little bit in the third quarter, it's already in our numbers, embedded in there, is the good old Chinese New Year, which this year is February 15th. And so that entire period of time tends to slow down somewhat in China. But it's coming in February this year. So I just thought I'd pass that on for what it's worth. So that's a little bit of color on some of the different markets and trends.

That's a lot of color. Just a very quick follow-on to that great information. I think you mentioned light construction, positive sequential and heavy construction lagging behind. Anything, obviously in January, any signs that the mobile OEM channel is improving into January?

There's some specific business that is going on out there that we've picked up and some of the specific customers, but broad based, no, we don't see a broad based major recovery on that side yet. I think we're a little ways off yet but I think it will come. But we're not seeing a major improvement at this time. But there are some customers that have captured certain business that we've enjoyed and will enjoy going forward and that's been a positive. But again, not across the board.

Thanks, Don, very helpful.

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

Thanks, good morning, everybody.

Good morning, Andy.

I guess just a quick follow-on to the market color that you provided, Don. Are you seeing any inventory restocking in any of your distribution channel at this point?

Our distribution is up on the order trends but, frankly, I don't see that happening yet. I think they're still being very cautious. What we're seeing is, what they're bringing in, they're shipping out. So I don't see restocking going on. I think that will be what will come down the road here a little bit as their confidence improves over what they've been through over the last 12, 18 months here. Nothing major at this point.

Okay. And then in your outlook for the second half, it doesn't really appear as if you're building any significant restocking assumption in there. Is that accurate?

For our own inventory?

Yes.

Is that what you mean, by our own inventory?

No, the inventory restocking.

In the channel. No, that's correct.

Andy, this is Tim. I think that after what we've just lived through here, I think that you'll find everybody through the whole channel being extremely cautious. Some people were caught with a fair amount of inventory, and we're a long way back, a long way to go, excuse me, to get back to where we were. So I think that as Don said, what we're seeing is pretty much hand to mouth, if you will. People are ordering what they need and it goes right through their organization, right out to wherever it's needed.

Okay. Thank you very much.

Thank you, Andy.

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

Good morning and wow, quite a quarter.

Good morning, Eli.

Good morning. Can we talk a little about the guidance, the improvement in sales forecast of both North America, Industrial, particularly international, which sort of down 10.5, 11% to down 4%. Especially with Europe being slow, where is that coming from? Have you put a change in currency? Does that include currency? Currency is now positive. Can you give us an idea of what's going on with that?

Eli, Tim. We never try to predict the currency. We're going off of -- really where we sit today, right. So we do not project whether we think it's going to go up or down. We tried that before and we didn't get it right. So I think --

That's a real improvement.

No, we're seeing things sort of -- right now, what we assume is the currency's will stay where they are. That isn't probably what will happen but it's the best we can do. In terms of the improvement, you're right, there is -- we are thoroughly surveying everybody throughout our organization, everyone is projecting these modest, steady increases to continue. But in point of fact, of course we do not have the orders in hand. So as Pam's given you, we do have -- the orders have picked up and we're expecting as I say those trends. But if -- we only carry six, eight weeks of backlog in the Industrial side, so it is -- who's to tell, right? We will have to see.

Yes, Asia and Latin America, without a doubt are doing quite well. We're seeing it here and there in the US, not universally. Europe is a bit problematic but starting to happen here or there. So we're giving you our best trajectory now. We do pick up workdays as well, in fairness. We have to declare that we pick up -- we always pick up a few extra workdays in the second half over the first half, so that helps somewhat.

Okay. Just help me again on the international number, particularly, you had an 8% currency benefit in the second quarter. Is that what's assuming now the rest of the year or what is your assumption of currency now in that number?

Basically, that's what -- in our outlook going forward, that's basically what would be there. It could be more, could be less, but that's about what we would assume, the same impact in the quarter that we just have been --

So much bigger than the first quarter. Is the bulk of the change between the second quarter -- between the second quarter guidance and the first quarter guidance mostly currency or is that some real -- that's what I'm trying to figure out?

In terms of the top line?

Yes, the top line, right.

Well, that clearly helped. There's no question about it. That clearly helped on the top line. As you know, it has a very nominal impact on the bottom line, there is impact plus or minus, but it clearly did help on the top.

That's the biggest portion of going from -- the midpoint of international was down 10, 6, now it's down a little under 4% but the biggest portion of that gain is the change in currency?

Right. There was a gain there. There would be a slight gain on the operating margin level but of course it would be fairly nominal at that level.

One quick follow-up. Do you think most of your sales improvement is overall market improvement or do you think you've gained a lot of market share? Because I don't see the industry is reporting as strong as numbers as you seems to have.

We let other people try to figure out -- I don't know how anybody figures out market share month to month, quarter-to-quarter. You can only figure that out over longer periods of time. I think it's more reflective of what's going on in the markets. I think that's the good news. It is reflective of what's happening in the markets.

Thank you.

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

Hi, good morning.

Good morning, Alex.

You mentioned earlier that -- I think early in the call that you saw the end markets improving. How do you define the end market for your Company?

How do we define the end market?

Yes, when you say the end markets are improving, Tim, what do you mean? What market is that?

Well, okay. So let's talk industrially and as you know, Alex that industrially, about darn near half of our business goes direct to customers and half goes through distribution.

Okay. So the end markets as you -- that you're talking about are the equipment companies that buy your stuff, that go into their machines, right?

Well --

Not their end markets.

It is equipment companies with machines. But it's also a lot of other people who don't build machines. You know, this could be going into life sciences and et cetera, et cetera. But those would be the end customers. We have what we call customers and we have distributors.

But let's suppose that you're selling something into construction equipment. You're talking about the construction equipment companies. You're not talking about the construction markets out there or the things that drive those things, right?

Well, our end customers are the construction people. Now, in that case too, especially with most of the larger construction people, they control their aftermarkets as well so they get both the OE sales and the aftermarket.

If Caterpillar reduced its components that it buys from you last year, the stuff it has in inventory and reduced their order rate, because they reduced inventory, they could be ordering twice as much right now from you, even though their markets haven't improved at all, isn't that the case?

That is correct.

So when you say the end markets are improving, you're really not talking about the ultimate end market, just your direct end market.

I think that might be true but you assume that they're just putting inventory on the shelf. We said earlier no one's putting inventory on the shelf.

They reduced last year, so now just to get enough components to maintain production, never mind replenishing inventory, just to maintain production, have to increase their orders to you, isn't that correct?

I think that, again, I can't speak for Caterpillar, I think there's a lot in the public domain about them having a lot of inventory when things slowed down that they were caught with a lot of inventory. They worked them down significantly and you guys know these numbers better than I do. And that they did -- a lot of people were writing that they were going to have to order a whole bunch of components just kind of to get their plants back up on the line.

Exactly. Exactly.

I can't really -- I don't know any of those numbers. I've heard those stories too. Caterpillar aside, and you guys -- people telling those stories, we do not see any customers carrying a bunch of inventory.

No. But if they reduced it last year, they have to increase their orders, forget the inventory replenishment. That's not even a factor yet.

Second question. The detrimental margin, very good in North America, 11%. I mean, it's almost as if most of your costs were variable here. And yet overseas it was 29% or rest of world negative so that's a lot worse. Why is there that big a difference? Is it charges or you mentioned that there were some of that in the form but why is there a big difference there?

First of all, 29% in international is outstanding. Remember, our guideline here is 30%.

I'm not saying it isn't but I'm saying your North America was even more outstanding and was a big difference between them.

So here's the -- it's a very good question and it gets right at the crux of what I was talking about earlier, and that is that in North America we were able to mobilize and execute our restructuring and get that behind us and done and realize the savings and all of the restructuring in North America is done, as in Asia, Latin America, and we're seeing those come through. There has been a tremendous lag in getting that restructuring done, so the costs have hit, haven't hit, are going to continue and the savings aren't all coming through. The wonderful news is they have done a lot -- I don't want to take anything away from them -- they have done a lot and they are already less than 30% and we're going to push on in and we'll make that even better.

Okay. Well, we have that to look forward to. Thank you.

Thank you, Alex.

Your next question comes from the line of Bob Cornell with Barclays Capital. Please proceed.

Yes, hi, everybody.

Hi, Bob.

Just expanding on the one point you mentioned back in December that big mobile customers who are saying be ready, be ready, be ready. What are they saying now?

Pretty much the same. We're starting to see some, Bob, so I wouldn't -- it's not like we're not getting anything. But we're not getting the big surge. Historically, we've talked about this before, historically coming out of one of these things, those guys would be in pretty strong and ordering heavily and we're not seeing that. We are seeing -- we are seeing increases.

Yes, Bob. I just want to add on about this mobile thing a little bit, because, I really get down and dig into these numbers from an orders perspective and look at them and mobile, in fact, if you just look at the second quarter sequentially to the first quarter, actually mobile increased more than the Industrial. But that hasn't been the case up until this last quarter. And when we talk about mobile, we're talking about a lot of different markets. We talk about cars and light trucks, we talk about heavy trucks, ag, lawn and turf, there's a lot of things that we include in that mobile number. So, not to paint a dire picture here, because if you just look at the percentage improvement, it's actually more than Industrial. But that hasn't been the case up until this last quarter.

Next question, maybe I missed it but I didn't hear you talk about the LIFO gain in the quarter. I think you were expecting one.

No, actually we did not have a gain this quarter. It went the opposite way, a little over $1 million.

Finally, I don't know whether you thing about it this way, but in terms of the benefit to margins, companies typically have temporary benefits, you have price cost which you did mention and then you have permanent restructuring cost takeout. Have you guys thought in terms of segregating the impact, positive impact on margins between temporary benefits that may reverse over the course of the next so many months, price cost being something else? I think you are still implying your net green and them permanent restructuring.

Well, Bob, this is Tim. In terms of the price cost, we talk about this, every business unit, every manager has their sales price index, they have their purchase price index, and they are charged with the responsibility keeping that at least neutral, get you ahead of it and again, we don't get down into the minutia on that but they do that. I think that the -- we do separate these down, but again, I think the -- we're looking for a lot of these, the improvements that have been made through this horrible period to in fact sustain. We are going -- we want to raise the ceiling out here, so we can raise the floor. And that's how you do it. But without getting more specific, that's -- we do track all that and -- but we do try to push it down to the division's unit level, give them key metrics, let them run their business.

That's my questions. Thank you.

Thanks, Bob.

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

Good morning.

Good morning, Mark.

Hey, when -- in answer to a question a little bit earlier about some of the cost actions and the benefits from that, one thing that was left out is the temporary furlough program that I think last quarter you mentioned was delivering something like $100 million on an annualized run rate, but there was a presumption that at some point you're going to have to bring those people back to full hours and reinstate what other cost freezes and things like that, so when does that occur? Was that a January 1 or is that -- are you still on furlough and reaping those benefits?

Mark, this is Don. What we've done now is we've basically eliminated the reduced workweeks for some of the corporation, the administrative part of the corporation, and the rest are on either a still 10% reduction, depending on the activity in their business. Some have gone down to a 5% reduction. And some are still on even more than that because their business is still real soft.

So it's really a mixed bag right now. We have eliminated for some of the organizations some portion of the organization, but some of the operating units that are really still down have decided -- and we let them do this one on one -- have decided to maintain a reduced workweek schedule.

So if we were getting a benefit of, say, $25 million just a quarter of that $100 million you talked about last time, if that came through in this quarter, second half it sounds like you won't be getting quite as much?

That's correct. That's all factored into the guidance Pam gave you.

Okay. Great. Then another follow-up on currency issue. With currency getting 4% to revenue that we talked about and the new outlook, what did that do to earnings and what's the expected full year benefit from currency on an EPS basis?

Again, Tim, I can't give you that number, Mark, but it's, again, nominal because we -- just simple math, if it's -- if we're making 10% -- if it's international and we're making 10%, if I pick $100 million up in sales, I'm probably going to pick up $100 million in operating margin, a tax effect is going to be $6.5 million, and then whatever EPS that is. That doesn't work all the time. It's just a rough approximation. So it's -- it could be a couple penny plus per quarter but not much. Of course, that's all contingent upon all the rates staying where they are today.

Okay. Then finally, what's the CapEx outlook and did that change from last quarter?

CapEx outlook has really not changed. Our people have been extremely cautious and conservative there and so I don't -- the outlook really hasn't changed. We don't expect people to be cranking anything up right now.

What's that number, Tim?

It was $30 million for last quarter, which is fairly consistent. So it's about 1.3% of sales.

Yes. We could go -- we could get up to one and-a-half, 1.6, but we're not going to be above 2% on CapEx.

Okay. Thank you.

Your next question comes from the line of David Raso with ISI Group. Please proceed.

Hi, good morning. Two quick questions. First, just thinking bigger picture about the cash flow strength of late, where the balance sheet is, looks like you have no acquisitions from revenues going forward because the last deal I believe was back in early December of 2008. Could you give us a little bit of an update of how you think of proceeding with growth. Typically you're good for on average 4, 5, 6% revenue growth versus the prior year sales, sort of kind of baked into your idea of growing the Company. And the second question is about North American margins but maybe I'll let you answer the first one.

David, this is Don. Absolutely. What we've been doing here of late is of course all of that excess cash has gone to pay down that $1 billion in commercial paper to pay for the acquisitions we did at the first half of last fiscal year. So we've got that house in order pretty well. What we plan to do is maintain our dividend record. We've talked about that before. We have 53 years now, we're going for 54. Not just paying dividends, but increasing every year for 54 years, and that's going to continue. So that's the next priority in line.

And then the third one is exactly what you're talking about. We want to finance growth, both-some of this is coming in the direction you're already seeing in Aerospace. We've gone from nonrecurring engineering type investments of $100 million to now $175 million a year, covering a lot of the new programs we've got going. So a lot of our -- we're investing in new growth in that regard. We're investing in growth in other areas with respect to new product development and activity. And then right now, basically reconnecting with opportunities or potential opportunities out there with respect to acquisitions. So yes, I think as we see our leverage drop to where it's dropping to, we're certainly going to use that balance sheet to help grow the business.

I know you can't indicate anything really imminent that's about to close but are there enough things on the docket where we should expect to continue to see some revenue from acquisitions? I don't remember the last quarter, you didn't have even $1 from acquired revenues.

I think what you're going to see is we're going to ramp up to about the level that we were at at a run rate prior to that, which is going to be on a compound growth, not any particular year, but over a five year stretch, we're going to average about 10% growth, half of that being acquisition. That's our target and we intend to continue that.

And lastly, last downturn it took you 11 quarters in North America to get the margins back up to double digits. This time it only took you three.

Right.

So you mentioned the idea of raising the floor to hopefully raising the ceiling. I know it's a big picture question but are you willing to talk about the North American margins which have historically peaked around 15, what are you thinking this time?

David, Tim. I talked about this just recently to a group of folks in New York and we want to average 15% over the cycle. We want to average 15. The only way we can do that is we've clearly got these margins to 16 or 17 when times are good and not let them get below 10, double-digit, when times are poor. So I think we definitely have raised that and we've got to continue to do that. So you're absolutely right. We can't get to 15 and be happy and complacent. We need to push on and try to get these to 16 to 17 to do this thing and I think that it's what we've been a working long, long time to achieve and I think we're on the cusp of doing that.

Okay.

The one area, David, that will affect that a little bit, as you recall, when we weren't doing much in the way of new engine -- we're always doing new engineering, but winning new programs in our Aerospace side of our business, we peaked out at 18%. Now, I think we're down around 11. Of course, we're in a soft market condition here. So the other wild card here is how many new programs are we going to take on and how much are we going to have to invest in those new programs. As you know, had we not taken on any any programs here, we would have at least $75 million more earnings flowing through that group than we do today. But again, it's -- like I said earlier in the call, we want to invest in the future and that's what we're doing. Regardless of what it does to the margin within a certain relative range. With that said, is the hybrid transmission, the hybrid technology we talked about in New York is that in the fiscal second half or is that a decision more for fiscal 2011? We have some business in the second half factored, we have a lot of cost from additional R&D effort that's factored in there as well. The last point, David, that I would point out, and it's good to kind of go over this now and then, is as we get back into an acquisition mode, okay, the other thing that does -- I'm not trying to down play how the margin's going to be lower because Tim said it just about perfect, that we're going to try to get to 16, 17, but what does -- another thing that does impact that is the fact that as you're bringing acquisitions on, you're amortizing the intangibles early on, that has a negative drag on the margins, but what it does in a very positive way, it throws off a lot of cash and that's the reason why we've been emphasizing cash flow here, because at the end of the day the cash is what we're going to be plowing into these acquisitions.

We might sacrifice a little bit on the operating margin, but you're going to like the cash side of the equation, as you have hopefully this past year, see what we've been able to do with all that cash that we've generated. That's great. Thank you.

Thanks, David.

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

Good morning, Ann.

Hi. Good morning, guys. Ann Duignan here. Hopefully you're not cutting back on costs so much or spending so much that you're not paying your utility bills and --

Good comment.

Anyway, my question, kind of building on David's question, actually. My understanding is your goal is for 15% EBIT is Company EBIT of 15 and Don, I guess my question to you is it looks to me like structurally CIC is going to have a real hard time contributing to that and not continuing to be a drag. Can you talk about a little about what your strategy is for CIC long-term. Will you have to do a large acquisition in order to get scale in that business and get that up to Company average or will -- divesting?

We like the CIC business, the direction that we've been headed. As you know, the focus has been more toward refrigeration, more toward the valve side of that business, the Industrial valve side, and de-emphasizing somewhat the automotive side. So we like that trend, what we're doing. Of course, they've been really impacted in a great way here of late because of the housing situation and the car market. Everything being down. The one thing that we look at CIC a little -- we look at all the operating units the same from the standpoint of one metric and that is return on net assets. Okay.

The real key driver in the Company is the return on net assets and the one thing that we've seen in that business in particular is that the asset intensity is not as great as some of the other businesses we have. So to get to the return on net assets metric that we have continue internally which is 21% pre-tax, we can get there with a lower than 15% margin in that business. So you have to keep that in mind too. And really, we talk about ROS and operating margins because that seems to be what the Street likes to talk about. But the bottom line internally in this company, the real driver is return on net assets at the end of the day.

So to answer your question, we think the margins there will be a little bit less than other groups in the Company, I think in some areas we may have groups that are a little bit higher. On average, though, we're saying as a portfolio we want to hit those kind of numbers that Tim talked about earlier.

Do you think you can get to those, closer to EBIT margins without a large acquisition to give you some scale?

Yes.

Okay. That's helpful. Just a quick follow-up on your guidance. Just trying to back into the numbers. Correct me if I'm wrong, Pam, but I think you said sequentially revenues up 5% in Q3, and another 5% in Q4.

That's correct.

And EPS up roughly 10% in Q3 and 10% sequentially in Q4.

Yes. Little more than that in the fourth quarter, but yes.

A little more. Okay.

Yes.

I guess what I was going to ask is, Don, embedded in your Q3 outlook is $17 million in restructuring which should not be there in Q4, so why wouldn't we expect Q4 EPS sequentially to be up more than 10?

Well, you have to remember, we had $80 million of carry-forward from the prior year, and so it's also dependent on the breakdown on that. You know, how that plays out from quarter-to-quarter.

And the savings that we won't get this year that are going to push into next, FY 2011.

You're going to push savings into fiscal 2011. Yes, I understand that. But you'll not have the $17 million spend.

Well --

We do have some in the fourth quarter. We do have some restructuring. But like I said, we also have that $80 million coming from the prior year in the breakdown and that is affecting that third and fourth quarter as well.

Okay. So you don't expect the $17 million restructuring spillover will all be in Q3, some of it will spill into Q4, is that how I should read it?

That's right.

That's helpful. I just wanted to make sure I interpreted that correctly. Thank you. I think most of my questions have been answered.

Thanks, Ann.

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

Hi, good morning.

Good morning, Jeff.

Just a quick question on Aerospace. You have it looks like a 10% sequential increase and just listening to Don's commentary around the trends, it feels like that business is still getting worse. Can you just comment on how you're looking at the back half relative to the first half in that business?

Sure. I don't think we see it getting worse. I mean, just as a reminder, you know, we're pretty much consistent with the guidance that we gave last quarter. They met the guidance that we really put out last quarter for them and the guidance remains consistent. So I don't think things are really getting worse. I think we had projected that the commercial aftermarket side of things would be down. But we said that there would be some offset in the second half due to retrofit. So we're pretty much -- the story is the same, Jeff. It's pretty much the same. We think that commercial market will be down. It will continue to be down in the 4 to 5% range. Once you factor in the retrofits which is offsetting some of the commercial aftermarket.

Sequential uptick is that just backlog-driven on the OE side or something else in.

We've had a little better military MRO than what we expected. Now, you know, military though is very lumpy and tends to even itself out over a longer period of time. And very hard to project as well. So we're being consistent with what we said last quarter.

The other thing, Jeff, is -- this is Tim. People are starting to fly again. Not like they used to, right, but people are starting to fly again. I mean, again, we took our furloughs back and we expect everybody -- we got those workdays back and people are out there working again, traveling a little bit. So there's a little help coming there.

Okay. Thanks.

Thank you.

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

Good morning, everybody.

Good morning.

I too would add my congratulations on a really terrific quarter. With profitability in the Industrial segments, I think you can be sure well above what anybody was forecasting, and the reason I think you're getting a lot of questions there is it's hard to see, for one thing, it's hard to see how you engineered the sequential improvement from the prior quarter, but I've been running the numbers on what you're implying for the second half and Industrial North America where you just did 13.5% margin on a 15% sales decline, you're looking at second half up almost 10% with operating margin no better than the December quarter. Similarly, international, the midpoints would lead you to profitability that would be roughly the same as the December quarter. And that I think you all know would be as unusual as the kind of sequential comparison that you just had in the December quarter. So, I mean, what are we looking at? Are we looking at something that was truly unusual and can't be repeated in the quarter? Or are we looking at very conservative forecasting on profitability?

This is Tim. I don't think we really think that most of what we've done is sustainable. I think, again, the one thing we talked about, there was certain international, certain amount of restructuring didn't get done.

Those are all small.

Those are relatively small. We think it's sustainable but on the other hand we think it was pretty darn good in performance, pretty stellar performance and, yes, so to project a huge upside from there -- we already have a very strong MROS. We talked about the kind of MROS we're going to have in the second half. We've done a tremendous job in this first half on the down side, on the decremental. We are going to be into positive numbers in the Q3 and Q4, and I think, we had originally given you like plus 45%. We're much higher than that right now. So I think --

the Industrial North America number is 69%.

Yes. Exactly. So I think we're about as -- we're about as far as we want to go on this. We said we had an improvement. We're putting improvement. We're doing well. So I think we're -- we don't feel like we're being conservative. We think we're being realistic. We think we can deliver these numbers. But we're not going to push any harder than that.

Let me ask you a separate question. Maybe Don, maybe this is really aimed for you. Again, we're talking about aspirational operating margin or return on sales numbers and I think it would be useful to -- since you haven't established a single fixed objective for the Company, I think it would be useful to make sure that we understand exactly what you're talking about. These averaging 15% operating margins, this is a number for the average of the segments, I believe, not an all-in corporate number?

No, it's for total Parker, Rob, total Parker.

Segment operating income, Rob.

So it would include unallocated corporate expenses?

Corporate expenses would be below, on a segment basis.

Okay. So it really is just the average of the segments?

That's right.

Okay. Because you don't -- as you know, you don't report an operating income number on the income statement, per se.

That's right.

Right, right.

So there's a little bit of -- I'm sure a little disagreement on what we're -- okay. So the relevant question for me, with corporate expenses running around or unallocated expenses by our calculation running around 3% of sales, is they some possibility of cutting into that number as well, as a means to improve? I don't know what all's in there besides goodwill amortization.

Well, Rob, there are a lot of things that play into that number below. I mean, on corporate expenses, obviously we always try to keep it to no more than 1.5% of sales, but then you get into that other category and there's things that can vary in there. For example, this year you have pension expense, which is in there, which that can swing pretty quickly. How big is the negative impact of that year-over-year for this year, Pam? I think running, it was about 24, just year-to-date, it was about 24.

I think we're looking at $60 million for the year.

For the year, right. And so next year, I mean, as you look out, that can swing pretty heavily. As interest rates go up and as the market comes back, so that could have an impact. If you looked last year, that was only about $58 million for the year. So that's one of the things that unfortunately can swing on us.

Now, Rob, this is Don. Just a couple comments on your initial question. We have been at the 15% or better in North America in the past.

Yes.

We've been at that number or higher. As a matter of fact, we were up to 18% on Aerospace in the past. We have been at that number or higher in Asia in the past., in Latin America in the past. And as you know the big drain or drag has been Europe in the past and that's what we worked on this last period, between 9/11/2001, let's say, and today. To try to get Europe up to where it needed to be and frankly, we got to 14% plus change in Europe before the whole collapse here. So we were working. And we think we're going to pick up of course. We're not going to fall all the the way back down to where we were. We're going to pick up where we're at and we're going to keep driving that up. We can't get there without Europe. We recognized that in the early 2000s and that's why we put all the work and effort into that.

You're trying to raise the floor there.

Exactly. Exactly. As we do that, there's nothing here that I think is not possible. I think this is very achievable. Something that we're all committed to do, this entire organization as we talk about it a lot and we make sure that we're measuring to that and I think you're going to see us back there in short order.

Yes, Rob. The big opportunity is right where Don is talking about. I mean, you can talk about these below the line numbers but really the opportunity is at the operation. So at this time, we're going to turn it over to Don for just a few closing comments.

Okay. Just a couple comments for you. First of all, I'd like to thank everyone for the nice congratulations. We're pretty excited about the quarter. We're excited about the way that the year is developing and of course any time we can raise guidance, that gets us pretty excited as well. But most importantly I think is the fact that we see these market segments and the order trends and the regions really starting to come back to life a little bit. Certainly, we would love to see it come back stronger, but the good news is it's in the positive direction. So we're encouraged and we think it's going to continue. We don't think this is a short-term aberration here.

We're going to continue to stay focused as a Company to maintaining a strong balance sheet. We've been committed to that, and I think we've done a great job. We were close to 40% debt as you may recall or leverage at the beginning of the year, being down below 30 and almost 27 on a net basis is pretty remarkable in this very, very difficult time period. So we're going to continue to manage for cash and also we're going to continue on as we mentioned earlier with the restructuring activities and with respect to dividends, I mentioned this but I'll just mention it again. Of course we're coming up on a dividend increase so we're going to be reviewing that here shortly so within the next quarter or so we're going to have to come out with something in the way of increase on dividends. So that's something we're very excited about as well, the fact they we're able to make it through this very, very difficult period and still be able to increase dividends year on year.

So I think with some bright spots on the horizon, we're certainly poised to emerge from this recession stronger than we've ever been before. I want to thank everybody for their participation. We certainly appreciate your interest in our Company, in Parker, and I would also like to thank on the call, I know there's a lot of Parker employees on the call, thank all the employees around the world for their continued commitment to serving our customers. And if you have any additional questions, Pam will be around for the balance of the day and so I'll sign off at this and just wish you a good day.

Have a great day. Bye now.

Thank you.

Ladies and gentlemen, this concludes the presentation and you may now disconnect. Thank you and have a good day.