派克漢尼汾 (PH) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second-quarter fiscal year 2012 Parker Hannifin Corporation earnings conference call. My name is Jasmine and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference to Ms. Pamela Huggins, Vice President and Treasurer. You may proceed.

Thank you very much, Jasmine. Good morning, everyone. This is Pam Huggins speaking. I would like to welcome you to Parker Hannifin's second-quarter fiscal year 2012 earnings release teleconference.

Joining me today is the Chairman, Chief Executive Officer and President, Don Washkewicz and Executive Vice President and Chief Financial Officer, Jon Marten.

For those of you who wish to do so, you can follow today's presentation with the PowerPoint slides that have been presented on Parker's website at www.phstock.com. And for those of you not online, the slides will remain posted on the Company's investor information website at the same location one year after today's call.

At this time, reference slide number 2 in the slide deck, which is the Safe Harbor disclosure statement addressing forward-looking statements and again, if you haven't already done so, please take note of this statement in its entirety.

Slide number 3, as you know, this is required and indicates that, in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers and again are posted on Parker's website.

To cover the agenda for today, on slide number 4, the call will be in four parts. First, Don, Chairman, Chief Executive Officer and President, will provide highlights for the quarter. Second, I will provide a review, including key performance measures of the second quarter and conclude with the fiscal 2012 guidance. The third part of the call will consist of our standard Q&A session and the fourth part of the call today, Don will close with some final comments.

At this time, I will turn it over to Don and ask that you refer to slide number 5 titled Second-Quarter Fiscal Year '12 Highlights.

Thanks, Pam and welcome to everyone on the call. To start the call, I'd just like to take a moment to point out some of the highlights for the quarter. First of all, just to make the overall comment that we have had just an outstanding quarter for the Company, not only an outstanding quarter, but an outstanding first half for the Company. So we are pretty excited about that.

We did see some demand moderating this quarter, which is what we anticipated. We had a December meeting with the investors in New York and we talked about that a little bit and especially as it pertains to our international business. So what is materializing is pretty much what we had seen building over the last several months. However, we are certainly pleased to announce a number of second-quarter records for the Company and I'll just kind of highlight a few of those for you here. We had record sales, net income and diluted earnings per share and those were all second-quarter records for the Company.

Total segment operating margins were also a second-quarter record at 14.2%. Keep in mind that the second quarter in our fiscal year, not just this fiscal year, but in any fiscal year, is typically our worst quarter and we have continued to remind everybody of that. And this year was no different, but to come in with 14.2%, we are pretty excited about those kind of numbers, being able to post those in one of the toughest quarters that we have in our fiscal year.

Again, those -- that margin, the 14.2%, was really driven by an outstanding performance in our industrial North American operations and they came in with 16.5% operating margins, so well above our 15% target.

The other thing I would note is that virtually all of our sales growth in the quarter was organic, very little in there for acquisitions, so it was virtually all organic growth. Orders increased, as you had seen in the press release, about 3% and have moderated. Again, at the beginning of this fiscal year, we pretty much predicted this, that the first half was going to be strong and the second half was going to be kind of single-digit growth numbers and that is pretty much what is materializing.

Now, albeit, the mix is a little different. We didn't expect North America to be quite as strong. We didn't expect international to be as weak as it is, but we have some offsets there. But all in all, we are pretty much doing what we anticipated to be doing for this fiscal year.

The backlog for the quarter, ending backlog, was up 4% compared with the same quarter a year ago, so we do have a build in backlog, which is a positive note. Operating cash flow remained strong at 9% of sales and we certainly like that number. I know there will be discussions about acquisitions and we can talk about that more. We are at pretty much various stages with regard to acquisitions on a number of acquisitions. We don't forecast acquisitions, we don't predict acquisitions because we never know when we are going to get them to the finish line. But as it is right now, there is a number that we are in negotiations with and hopefully some of these will close before the end of the year. So that would be a positive going forward.

We have acquired about $20 million in incremental sales this fiscal year so far in addition to the buyout of a joint venture that we had in China. Yesterday, we announced an offer to buy out the remaining shares of TAIYO Limited of Japan and we have been a majority shareholder there since about 2006.

Now I will just talk a little bit about the international segment. You've, obviously, heard a lot about the international if you have been reading the papers and paying attention to the news. There is a lot of well-publicized and ongoing information about how unstable the conditions are in the international segment, especially in Europe across a number of our key end markets.

We have adjusted our full-year diluted earnings per share guidance back to where we were at the beginning of the year. If you recall when we started this fiscal year, we had kind of a nominal $7.10 for the year guidance and we increased that guidance after the first quarter because we actually beat the first quarter by about $0.30 I believe the number was. So we added that back to the guidance and that is where we ended up with the higher number. And we are now bringing the number back down to where we were at the beginning of the fiscal based on what we are seeing right now. So the mix hasn't been the same, like I said earlier, but the end result is going to bring us right back into that nominal $7.10 plus or minus kind of territory.

We expect current North America conditions to continue through the balance of the year and the strength is not just coming from one market segment; it is coming from a broad range of market segments. We can talk later about PMIs and different specific segments and what we are seeing. I can give you a little color on that later. But right now, we don't anticipate anything bad happening in North America, any negatives coming out of what is happening elsewhere in the world, at least at this point in time.

So right now, we expect that, for fiscal 2012, earnings from continuing operations, like I said, would range somewhere between $6.90 and $7.30 and that nominal is somewhere around $7.10 and that represents about a 6% adjustment from where we were previous and still anticipates an all-time record year for the Company. So we will talk more about that after Pam gives you some more detailed review of the quarter.

Thanks, Don. So at this time, I will ask that you reference slide number 6 and I will begin by addressing the earnings per share for the quarter. Fully diluted earnings per share for the second quarter came in at $1.56, in line with what you saw on the press release this morning. This is an increase of $0.17, or 12%, versus the $1.39 from the same quarter a year ago. And while the $1.56 is down sequentially from the first quarter, this is normal for Parker due to the natural cycle of the business and in line with historical performance.

But to get back to the $0.17 increase in earnings per share for the second quarter, let me just outline for you the puts and takes of that $0.17. Segment operating income added $0.19, higher expenses below segment operating income impacted EPS by $0.04, a higher tax rate impacted EPS by $0.09 and a lower share count had a favorable EPS impact of $0.11.

Sales were higher in all segments of the business with the exception of Climate and Industrial Controls group and all segments generated increased operating income year-over-year with the exception of international. International was slightly less than last year in spite of the sovereign debt issues and slowing economy in Europe and Asia. The less-than-expected performance in international was due to less sales than anticipated on a higher expense base, continued investment in Asia and the impact of currency, mainly the euro, as it continued to weaken throughout the quarter against the dollar. And I am sure we will talk about these issues a little further as we go through the call.

Expenses below segment operating income were impacted by higher corporate G&A and that was due to higher research and development costs and performance incentives. The higher tax rate was due to a higher mix of domestic sales versus foreign and of course, we always have this multi-period R&D tax credit that was booked in the second quarter last year. And the lower share count is the result of share repurchases.

So moving to slide number 8, looking at the top line, revenues for the year increased 8.4% to $3.1 billion and that is over $2.9 billion last year and sales increased across all segments of the business again except CIC. But you should note that CIC generated slightly more income on less sales.

There was a minimal impact from acquisitions and currency in the quarter and as a result, the organic growth was the same as the top line, 8%. Segment operating margins for the quarter increased 20 basis points from 14% to 14.2%. Again, as Don said, an all-time second-quarter record for the Company.

So now moving to slide number 9 focusing on the segments for just a moment commencing with North America, North America revenues came in at 13.2% for the quarter. Acquisitions and currency had little impact, such the organic or core revenue increased 13% as well. Operating income increased from $159 million to $196 million and this is a 23% increase for the quarter year-over-year. Operating margins for the quarter increased to 16.5% from 15.2%.

So moving to slide number 10 and continuing with the Industrial segment, but moving to international, organic revenues increased 5.3% in the year. Again, currency had minimal impact on revenues. Acquisitions added 1% to revenues in the quarter and so total revenues for the quarter increased 6.2%. Segment operating income decreased to $166 million from $168 million and operating margins decreased to 13.6% from 14.6%. And again, due to the reasons that I cited earlier.

Moving to slide number 11 and focusing on the Aerospace segment, Aerospace reported revenues increased 8%. Again, acquisitions and currency had no impact to revenues. Margins increased 40 basis points for the quarter to 14.2% from 13.8% last year and this, of course, is due in large part to the higher sales volume.

Moving to slide number 12 and addressing the Climate and Industrial Controls segment, revenues decreased 3% for the year. However, margins were up in spite of the decreased sales. Segment operating margins as a percent of sales were 4.7% for the quarter versus 4.4% last year. And this is obviously due to the continued restructuring efforts that we have talked about over the last several calls and again, restructuring going on over time in that group and so you are seeing some of that in that bottom-line number.

Moving to slide number 13, addressing orders for a moment. Just to remind everybody, these numbers represent a trailing three-month average and they are reported as a percentage increase of absolute dollars year-over-year, excluding acquisitions and currency except for Aerospace. And Aerospace has reported using a 12-month rolling average.

As you can see from this slide, orders are up 3% for the December quarter just ended. North American orders increased 8%; Industrial international orders increased 1%; Aerospace quarters were flat; and Climate and Industrial Control orders decreased 5% due to the continued weakness in their markets.

So I would like to move to the balance sheet just for a moment here. Parkers' balance sheet, of course, remains solid. Cash on the balance sheet at year-end was over $488 million. Days sales in inventory increased to 63 days from 62 last quarter and that is pretty much typical for Parker. We tend to build a little inventory in the first half and then we tend to reduce it even more than what we build in the first half and the second half. Accounts receivable in terms of DSO closed at 48 days, consistent with the first quarter and weighted average days payable outstanding increased to 54 days versus 51 last year.

So moving to slide 15 and addressing cash flow, cash flow from operations for the quarter came in at $254 million, 8.2% of sales and on a year-to-date basis, $563 million, or 8.9% of sales. The major components of the uses of the quarterly cash flow of $250 million in the quarter is as follows -- $76 million returned to the shareholders via share repurchase of $20 million and dividend payments of $56 million; $53 million, or 1.7% of revenues utilized for capital expenditure purposes. However, please note that capital expenditure purposes on a year-to-date basis is only 1.5%. So 1.7% for the quarter, 1.5% on a year-to-date basis.

In addition to these uses of cash, cash did decrease another $50 million in the quarter and that was mainly due to the effect of exchange rate changes on the cash. And total cash increased $64 million in the quarter.

Moving to slide 16, you can see that the debt to total cap ratio was 25.2% and on a net basis, 19.5%. So obviously the Company has a lot of capacity to grow the business moving forward.

What you have all been waiting for on slide 17 and 18, the revised guidance. On slide 17, the guidance ranges are reported for revenue and operating margin by segment. And on slide 18, the guidance has been provided at the midpoint and in total for the items below segment operating margin.

And on slide 19, the guidance is summarized on a diluted earnings per share basis. As you can see from this slide, the revised guidance for the fiscal year is projected to be $6.90 to $7.30. This revised guidance range incorporates the low end of the previous guidance provided last quarter.

So please remember that the revised guidance excludes any acquisitions that may be made in the second half of this year and just to summarize some of the assumptions in the guidance for you, revenues increased almost 6% at the midpoint. Operating margins are projected to be in the range of 14.8% to 15.2%, a pretty narrow range. Expenses below segment operating income, including the corporate administration interest and other at the midpoint, are projected at $412 million with a very small band of plus or minus 0.5%.

The projected full-year tax rate at 29% and just a couple of points with respect to guidance. Sales first half/second half are divided 49%/51%. EPS first half/second half are divided 49%/51%. Realignment costs for the year projected at $0.10 and $0.03 has already been incurred and the remaining projected expenses will hit in the second half.

Fourth quarter will be stronger than third quarter. Approximately 46% of the total EPS for the second half will be in the third quarter. The fourth quarter will have higher sales and there are some expenses occurring in the third quarter that won't repeat in the fourth quarter, such as restructuring, legal fees, inventory expenses, as well as some inventory -- as well as expenses associated with inventory reduction.

So at this time, I would just like to open the session to our standard Q&A. And as a reminder, please be courteous, limit your questions to one at a time. If you need clarification, that is fine, have a follow-on, but we would like to give everybody a chance to participate. So at this time, please open the call.

(Operator Instructions). Jamie Cook, Credit Suisse.

Hi, good morning. I guess, Pam or Don, just a couple of quick questions. When we look at your order trends, you were nice enough to give us the October and November order trends when we were at your Analyst Day and it just implies sort of December sort of fell off a cliff and I guess what surprises me is Aero took a big hit and North America took a big hit whereas rest of world where everyone was surprised, it didn't seem like -- you know what I mean? It saw a material decline. So I am just wondering if you can sort of explain that. Was there anything in the quarter? Is it seasonality in December? Was there less business days? If you could sort of just speak to that.

And then my second question -- can you just comment about inventory levels at Parker and what needs to -- and the level that you will need to reduce that and inventory levels at the distribution level?

Jamie, this is Jon. I am going to try to first handle the orders questions here and let me just start out with Aerospace. The Aerospace orders are really as a result of very, very tough comps. We are at all-time record highs in terms of the backlog there and again Aerospace being on a 12-month rolling number here. There's a lot of changes as we look at what would have been dropping off the period 12 months ago. So I wouldn't read too much into that.

Now, as you mentioned, in the Investor Day discussion that we had in December, at the beginning of December, we had just gotten our November numbers. And you are right. As things rolled through in the month of December and for the quarter, we got progressively weaker in terms of our inventories in North America, as well as in Europe.

However, the point, I think the key point for North America, our projections for North America in terms of our revenue that are built into our guidance is quite healthy and we are really relying on those projections where we are going to see a rebound in North America as the quarter goes on and into Q4. So we feel very good about our projections in North America in terms of revenues.

Internationally, we have baked in the decrease that we saw in December into our revenue forecasts and we are going to see really two effects. One, the ability for us to make sure that we are launching every single month the order rates that we are seeing in Europe and making sure that we are able to keep our cost structure in line. And then internationally in terms of areas other than Europe, primarily Asia, of course, for us, we would expect to see an increase over time throughout the third quarter, beginning in the end of February, beginning of March timeframe in Asia and then that increased building in Asia throughout the year.

So you are right. By deduction, our December was not as strong as we would have liked, but there is often, when you are looking at just one period of time, some seasonality issues there. And of course, the uncertainty related to the situation in Europe would have sure affected some orders here at some point in the month of December. But as we look forward and we look at the demand patterns that we are expecting from our customers, we feel like we have it really solidly built into our forecast going forward.

And as we looked at the data for the year, for the second half, we will still end up with a -- have mid-single digit organic growth for the Company. We will be at about 6% for the Company overall for the year. And so we will still be meeting all of our organic goals that we commit to everybody here every year, which has been part of our strategy. And of course, as you know, it doesn't include anything that we will be planning on doing in terms of acquisitions.

And then just the second follow-up question on the inventory levels at Parker at the distributor basis.

Yes, I think -- we don't have any information that would lead us to believe that the inventory levels at the distributors are any different than they have been, so normally at this time of the year. Although our inventory is up as a company, as Pam mentioned in her comments. The inventory goes up seasonally for us in Q2 and then we always drive it down. I think we are at 63 days of sales, 63 days of inventory on hand at 12/31 and we were really at 55 days of inventory on hand at June 30 and we intend to be well below that 55 days by the time we get to June. And that is built into our planning here for the second half. But in terms of the actual inventory on hand at our distributors, we think that we are pretty much in the same band that we are normally in given this time of year.

Jamie, did you want -- this is Don. Did you want to know something more about the distribution?

No, I guess my follow-up question really isn't on distribution; it is more -- I mean, again, on the order trends, you guys cite -- or Jon, you cited I think a little bit of seasonality. That shouldn't impact us year-over-year. So I guess I don't get that. Was there something specific to this -- I mean was there -- I think GE this morning said there were less business days or something. I mean did any of that impact you? I am just trying to get -- it just doesn't make sense.

Well, the thing that, for us, in the month of December -- again, we shared the October and the November data with you in the meeting at the beginning of December and in the month of December, we saw a worsening of the order rates year-over-year. And when I mentioned seasonality, all I was doing was trying to compare what is happening in Q2 versus Q1 and just tried to (inaudible) our normal rates are going down. I understand year-over-year that we are in the same impact.

However, I do think it is fair to say, in terms of Europe and what is happening in Europe, that there is some uncertainty and in some pockets of our organization in Europe, we saw some order rates that we wouldn't normally see in the month of December in Europe. But our look at Europe going forward is baked into our guidance and we feel very good about being able to make our organic growth rates as projected in our revenue forecast that just Pam described earlier.

Jamie, this is Don. Just to add a couple points to that. First of all, the strongest segment for Parker right now is our distributor business. It's absolutely the strongest of all of our segments, OEM or otherwise. And so I don't anticipate our distribution cutting inventory or adjusting down inventory. If anything, they might even be adding some inventory to deal with their business conditions because that is really the driver right now in the Company is the aftermarket. In particular, it is the strongest segment for us.

The other thing to keep in mind is December is always a lousy month. I like December, don't get me wrong, because I like the holidays and all that. But from a business standpoint, it is a lousy month and with the holidays and all that and every December is -- we don't have a good December typically ever. I mean really when you look back through the years, it is a light month. You can't read a whole lot into it.

I think more importantly stay focused on our backlog. And in the second quarter compared to last year the second quarter, our backlog increased 4%. That is kind of an indicator going forward as to what is to come, okay? So we are building some backlog from year to year, quarter to quarter and I think that is probably more important than try to read too much into one month of December.

Okay, I appreciate it. I will let someone get back in queue. Thank you.

Jeff Hammond, KeyBanc.

Hi, good morning. Just on the -- so if we take the guidance revision of $0.45, is there a way to bucket that between European weakness, FX translation, anything else? And maybe within the international business, if you can just kind of correlate the organic growth with the margin decline. Is that price cost, is that mix, is that inventory absorption?

I think, Jeff, Jon here again, in terms of the guidance, the whole story is really when you look at the numbers going forward as we have broken it down by segment is in our international business and it is both in terms of revenue, as well as in terms of margins. We have also got a little bit in there for -- we have raised the tax rate up to 29% from 28% and that is the way that we are really looking at the guidance for us and the change in the guidance. So that is the whole picture.

If you really looked at our prior guidance versus our current guidance, we are at a $0.37 impact there. So that just about covers that entire $0.45 that you are talking about. And that gets to the point that Jamie was making earlier that we try to talk about in terms of our view of the international growth rates. And as we tried to talk about in December, we were worried and we said that we were worried in December about the trends that were developing internationally for us, especially in Europe. But we were also very mindful of the strength that we were seeing in North America. And we really wanted to be able to tell you exactly what was going to happen at the end of the quarter. We didn't know, of course. We were only through two months and we had just gotten the fresh November data.

But once we finished the quarter and we go back and we look at it, we almost covered on North America. North America is increasing in our guidance as the year goes on and it is just not able to give us the confidence that we are going to be able to cover what we are seeing internationally, both in Asia, but, of course, primarily in Europe. And that is probably the picture in a nutshell for you. But it is all international. It is not anything else other than that and we are going to be keeping a really strong focus on that.

As Pam mentioned, we talked about -- she talked in detail about the difference between the expenses that we have got baked into the guidance for Q3 versus Q4. And in fact, we have got about $20 million in additional expenses, mostly restructuring related to what is happening in Europe into Q3. We will also have some legal and other types of costs that we have got baked into Q3 guidance too here.

So we see the issues. We see the influences on us. It is consistent, as Don said, with the macroeconomic picture and we are taking action. We are taking action based on what we are seeing and how those markets are trending in order to be sure that we come in with the guidance that we have provided you here today. So we feel very good about our visibility into Q3 and we are very confident in the guidance that we have just given you.

Okay. Is there a way to quantify the FX translation impact either on the EPS guidance change or on this five-point swing in international revenue growth at the midpoint?

Well, I think that, in terms of the top line, about half of the top-line delta between our old guidance and our current guidance is FX-related and that will have a material impact on the bottom line for us. And we can get into a lot more detail with you as the day wears on here if you would like.

Okay, thanks.

Joel Tiss, Buckingham Research.

Wow, I made it before the end. How's it going? I just wanted to follow-up on the direction that Jamie was going into. And I don't know if you guys want to answer this, but I think it would be very helpful for everyone on the call if you could give us a little bit of a sense if you are a calendar year, what 2012, sort of the order growth rates and pricing trends and some more color on different regional trends, what you're seeing. There is a lot of different parts of Europe. You haven't talked about Latin America at all and I just wondered if you could give us more of like a snapshot of how you are seeing calendar 2012 and what the January order rates -- like what the order rates look like and what you are hearing from your customers, more on that kind of a view.

Well, Joel, I am not sure where we want to start on that. I can maybe start with a little bit of what you may already know, maybe not everybody on the call knows about the PMIs and what they are looking like globally. But right now, what we are looking at is, on a global basis, PMI is around 50, which is kind of neutral territory for the overall market globally, but not a bad number. North America I think bodes well and is pretty much in line with what we have been saying here is that the PMI increased to almost 54 from about 50, just under 53 in November. So actually the activity in North America -- that was for North America; I don't know if I mentioned that. So for North America, we kind of see that going into the new year as a real good sign.

The eurozone, now it actually went up just a little bit from low 46 to higher 46, but nothing really to write home about. All of the Western countries in Europe for the most part are below 50. So that just kind of confirms the weakness that we are seeing here.

China is around 49%, just a little bit less than that; it was closer to 50% in September, so down a little bit. We anticipated, by the way, with our guidance at the beginning of the year that our first half was going to be strong and our second half was going to be weak. So none of this really surprises us; it is just maybe some of the pieces moved a little bit here or there. But I think what we are seeing develop is pretty much exactly the picture that we saw going in and we said that our growth would be kind of single digit in the second half and that is kind of the way it is materializing.

You mentioned Brazil. Actually, their PMI, they have been kind of flat-lined for quite awhile, but they have actually increased a little bit on the PMI now to around 49 from 45 the previous quarter, so that is kind of moving up. You saw our order trends were up about 3% and I think most importantly, again, is the backlog that we are running about up 4% quarter-over-quarter. I think that is kind of an indicator of what is to come going forward.

I could go into the order trends by region, but I think I am just going to be repeating myself. I have got 3/12s and 12/12s. I would say the strongest trend for us anywhere in the world is our North American distribution. It is the strongest trend both on a 3/12 and a 12/12 that I see anywhere in all of the regions and segments that we deal in.

What else? I think that is probably -- I mean I can go into specifics -- some specific segments and so forth. Like semiconductor is flattening. Refrigeration, of course, we talked about that with CIC and air conditioning is weak. Housing builds, of course, are dictating that. Construction is, on a 12/12 basis, is pretty strong, the 3/12 is coming down a little bit, but that is to be expected.

So those would be just some inputs. I hope I answered a little bit of what you were looking for.

Yes, and just on Aerospace, can you give us a sense of why the growth? It looks like if you -- I know you don't report it this way -- but if you just took the fourth calendar quarter of 2011, it looks like the growth really fell off a lot. You said it was tough comps. Is there anything in commercial aftermarket that would have amplified that?

Yes, I would think that the commercial aftermarket is still very strong and very good. The impact that we are seeing or the headwinds in the Aerospace orders going forward is, of course, the defense business and this would be defense OEM, as well as the defense aftermarket.

The commercial side of the business is still very good and we are expecting the guidance that we gave there to continue strong. We are still, as we talked about in the Investor Day presentations that we made, referencing an 8% compounded annual growth rate for the next several years in Aerospace based upon all of the wins that we have been able to make over the last year. So you might see some changes in the backlog, but those were all anticipated and that is really more related to the defense than the commercial side of the business.

Okay, thank you very much.

Joel, I will just add one other thing I wanted to just cover. Just some specific market segments that I can just give you a little color on, North America, strong segment, it is doing better. Mining, oil and gas, power gen. I mentioned distribution being extremely good for us. Those would be some other segments that are looking good. Worse would be semiconductor and heavy truck. Although heavy truck is running at a fairly high level, so don't read too much into that.

Internationally, this would be primarily Europe now that I would be talking about, the mobile markets are soft; cars, light trucks soft; construction, heavy-duty truck, those are all soft and farm and ag. So you can see pretty much across the board those segments in Europe are soft.

On the positive side, power gen, semiconductors is more positive now than it has been, but it is a small change. Marine is strong, oil and gas is strong. So you can see the power and energy markets are doing pretty well even in that environment internationally. And that specifically was speaking to Europe.

China would follow that pretty much exactly along the same lines as I just mentioned for Europe with the exception that cars and light trucks are still good in China. So the rest of the segment is pretty much parallel with what I just said. Hopefully that adds a little color to you.

Yes, thank you. Sorry for taking so much time.

David Raso, ISI Group.

Hi, good morning. First, a clarification. At the analyst meeting, you were providing rolling three-month orders, right? So it wasn't that North America was up 18% in October and 13% in November standalone then you back into a down December? Those were rolling three-month numbers you were providing for October and November, correct?

That is correct, yes.

Thank you. My question relates to -- I think it was Jon that made the comment that organic growth for the Company in the back half could be -- I think you said 6%.

What I meant there is 6% for the year for the Company. We are going to be in the 1% to 3% range. 3% is the implied guidance for organic growth for the second half of the year.

Okay because I am trying to back into the currency impact you are baking into international and what that is implying for organic international for the back half because the full-in number is back half you are saying international revenues down 4.7, but margins only down 10 bps year-over-year in the back half. So how much is currency in the second half for international? Is it 5? I am just trying to think are we implying organic growth internationally as flattish in the back half.

You are about there, David.

Okay. And not to -- I apologize for repeating my question from last quarter, but, unfortunately, it kind of happened again with the international margins. If we were down 60 bps in international margins in the first quarter, now 100, you would think that the outlook is weakening here a little bit, at least the next coming quarter, to have margins only down 10 bps year-over-year in the second half. Again, just a question from last quarter, why would the margins be only down 10 if we are not growing the business at all and costs have gone up in Asia and who knows, maybe even the currency is a bit of a drag on the profitability. I think that is a debatable point, but can you explain what the margin is only down 10 bps in the second half internationally?

I have a little more than that, so I don't know where we have a disconnect in our numbers, but there is a little bit of disconnect in the numbers.

Well, back half '11, 15% international margins. Second half implied 14.9%. Maybe you are off by 10 bps or so from my number, but (multiple speakers) it's usually inherent that business like this flat organic growth at best doesn't usually imply margins flat or down slightly. Usually take a bit of a hit. Is there something with -- well, actually the currency going away -- your currency is less of a drag on profitability because you don't have the same margin on a currency dollar. I am just trying -- you would think it would be a little more --.

Well, part of it is because of the European margin. You have to remember that our European margins are lower than the margins in the rest of our business. So the currency does have a much smaller impact to the profitability than what maybe you might see on the sales line.

A that is my last question. The international -- obviously, everybody is thinking about Europe. I am a little more concerned around the margins in the emerging markets because that would be more of an unpleasant surprise to folks. They at least feel like they can somewhat calibrate Europe potentially. The emerging market margins, how are those trending right now? I mean all in with the investments as well, but even just with investments, without the investments, international margins, how are they trending right now?

That's a good question.

I think that -- and David, this gets to the point that you made -- you were asking about earlier. As our international business changes over time, of course, we are growing bigger in our emerging markets than we are in Europe. And so the margins are changing at a different rate in Europe, vis-a-vis what is happening in Asia as an example.

However, as we've talked about before, our margins in Asia are very, very good, but they are slightly down from where they were. That is having an impact on us. They are slightly down because we are putting in, as we have talked about before, an infrastructure there and some of our CapEx program and we are creating opportunities for us to really invest in growth for the future. And so it just so happens that, as these facilities are coming online in Asia, they are having a very minor, but noticeable impact to us in terms of the margins internationally. Again, we are very proud of our emerging market margins, but your point is well-taken and your analysis of the situation is accurate.

And that has triggered a question for me. You made the comment about EMs maybe getting better. I think you said Asia to be specific. Is there anything in the order book to suggest a pickup? Because, again, I am just not hearing that post Chinese New Year pop that we usually get. So the cap goods post Chinese New Year seems at the moment -- going to be a little disappointing. Are you hearing something differently or are you looking even kind of beyond that March/April timeframe and there is something in your order book suggesting that pickup in April/May because I'm just --?

Well, I think in China, it has been down for quite a while now. I think that just from what we have been hearing as far as the banks and the access to capital and so forth is being softened or released a little bit, lessened, more available, however you want to put it, I think that is going to bode well. The only question that we have is what month or months is that going to really happen. Our people in Asia say that it is going to happen the second half. We can't pinpoint. We were hoping that it would start in January. It looks like it may be pushed out a little bit, but I am hopeful that still we start seeing a little bit of a pickup in the third quarter sometime.

So it is a macro thought, not a micro order book thought.

Yes, yes, exactly.

I appreciate the color. Thank you very much.

Robert McCarthy, Robert W. Baird.

Good morning, everybody. Before I ask a question, Jon, could I just ask you to clarify something you said before? The $20 million of excess expenses in the third quarter is a combination of restructuring and other things or was it $20 million for restructuring alone?

It is primarily restructuring, but we also have some incremental legal expenses that we will be incurring in Q3 related to some of the projects that we are working on. So three-quarters of it certainly is restructuring.

And I just want to clarify because I don't want you to think that -- it is a combination of things. The third quarter, what is happening is we are having some expenses that won't repeat and then in the fourth quarter, we have some pickup of some inventory adjustments and things like that. So it is not like we have -- everything is in the third quarter and it is going to reverse in the fourth quarter. It is a combination of things that are happening in the third quarter versus fourth quarter and that is the change. So it is $21 million in total though.

$21 million, okay. So my first question was just -- I would like to try to distill down all that we have heard about the international outlook into an order expectation. So I think I hear you saying that you believe that recovering order rates in Asia, perhaps Latin America, will enable overall international orders in the second quarter to be up. In other words, fully offset what you think is going to happen in Europe and allow orders to be up. Am I getting the message correctly?

Yes, the second half, we are expecting orders in our emerging markets to increase sequentially as the third quarter rolls out and into the fourth quarter.

I apologize, Jon. I meant to say fourth quarter, of course.

Okay. So that is how we are looking at our guidance and that is what we are expecting and that, again, is as a result of our analysis of our forecasts that we are getting from each one of our business units and the geographies and the territories that they are looking at and very close to their customers. So this is not just a macro look at the world and trying to apply it to our numbers. This is a combination of that plus the roll-up of all the data for all the divisions around the world and that is exactly what we are expecting.

Got it. And then my follow-up has to do with your expectations for Aerospace profitability. Obviously, we understand some of the puts and takes. I am surprised to see you forecasting that second-half margins would decline from the first half despite an increase in the second half in terms of revenue. And my impression has been that we have some easing of the engineering expense issue. So are we looking at the impact of an adverse mix shift created by more commercial, less military?

Yes, you have got it very well put. We still have the engineering expenses continuing in the second half, slightly less rate than the first half, but still in the 9% to 10% range of revenues for the year. And you are absolutely correct. It is the mix between the commercial and military, but it is also the mix in terms of the OEM build cycle. As the OEM build cycle continues to gain momentum, of course, that's causing a mix issue for us and we are putting our guidance together with that in mind.

Our commercial aftermarket is at a very, very nice level right now for us. But we expect that to be flattening out as the year goes on, not giving us the momentum that we have had over time and as the OEM commercial business comes online, that will create that mix issue, which may be a 100 basis point difference in the returns at the operating margin there.

Thank you, Jon. That's very helpful.

Alex Blanton, Clear Harbor Asset Management.

Good morning. Can you hear me?

Yes, we can hear your.

My question, Pam, relates to something you said during your opening remarks. With regard to the second half, you were talking about 49% of EPS in the first half and 51% in the second. So that would give you about $3.63 in the second half. And then you said 40% of that second half would be in the third quarter and 60% of it fourth quarter. Is that correct?

Yes, I think my exact numbers were 46% in the third, but --.

Oh, well, you said 40%, because if you use 40%, that would give you $1.45 and that looked a little bit light.

No, it is 46% in the third.

46% and 54%.

Yes.

Okay. Thank you for clarifying that because I was getting a little concerned. And that would give you $1.67 in the third quarter, which then you said would be burdened by about $0.12, including restructuring and legal costs, correct?

Yes.

Now, the other question is the decline in the margins in the quarter in international -- I apologize if this has been covered before -- but it was on higher sales. Why is that? I mean there was no incremental margin.

Well, I think what has happened is that our anticipation for the business was higher than what exactly happened and when you have a fixed infrastructure, it is hard to adjust real-time to the moment to any change in activity. So you're going to see some aberrations there early on in a situation like this.

We will be making adjustments and those will happen real-time, but there is a little delay factor. They get adjusted to what the current levels are. We anticipated a higher level of activity than what actually happened for the amount of infrastructure we had in place and the staffing and all that. So those adjustments will happen; it will just be a little delay.

Okay. So your sales were lower than expected, so your expenses were too high a percent?

Some of the fixed expenses were just that. They were fixed.

Well, are you going to reduce them in the second half?

Sure. We are reducing everything real-time as we speak. As you know, certain regions of the world are easier to do that. Other regions are a little bit more difficult because you get the Vatican to approve it and whatever as far as cutbacks. And I am just pulling your leg there a little bit, but you have to get the Works Councils and the governments to approve things and so forth.

Yes, that is a little harder over there.

But we are doing that. We are making the adjustments as needed. I will say this that, in Europe in particular, we have about, right now, about 1000 associate employees and we prepared for this. At the last recession, we were preparing for the next recession because one of the parts of our gameplan is to make sure that we do have associate employees that we can act on a little bit quicker than we would otherwise be able to do with full-time tenured employees.

So we have about 1000 -- we have a couple thousand in the Company total. We have about 1000 of those in Europe and that was down to zero in the recession. So you can see the flex that we have there. It is about a 5% of our workforce flex that we have with temporaries and associates to be able to manage through these kind of downturns. So you are not going to get much of a delay; you will have a little bit of a delay. There is still some restructuring, I think Pam mentioned that, going on over there. That is an ongoing thing. It is not a huge number, but it is happening and it will continue to happen until we rightsize everything to the level of activity.

Just along the same lines then, CapEx, maybe a question in your mind, what is happening with CapEx. Well, keep in mind that, in a lean environment, lean drives discipline in CapEx. I don't have to take any drastic measures on CapEx when the economy goes up or down. It happens automatically. When you really have a lean environment, you are monitoring that almost daily. So we are running right now at about 1.5% of CapEx. That is at a pretty low level already and it is pretty reflective of where I would expect to be with this kind of an economic environment that we are facing. So those are some of the things that we are doing to address what is happening over especially in Europe and international. I can give you a few more, but I think that kind of hits the highlights.

Thanks, Don.

Terry Darling, Goldman Sachs.

Thanks. A couple more clarifications here. Jon, I think, at the analyst meeting, you did give the indication that November orders, Industrial international, single month November was just very slightly positive. Can you help us with December? I think the implication is you went just slightly negative in December and if that is correct, is it Europe got a little worse and Asia was still about as negative as it was in November? Or can you help us with any of that?

Your logic is correct. It did get worse in December. It did go negative a little bit and it is about equal -- equal by region.

Equally negative or equally deteriorated versus November?

Equally deteriorated, vis-a-vis November in both Europe, as well as in Asia.

Okay, helpful. And then in terms of the question on second-half international margins kind of essentially the same for the second half despite the lower revenue, I wonder if you see an expanding price raw material gap. Maybe you can talk about where that is now and where you see that heading moving forward.

This is Don, Terry. We've had raw materials right now -- maybe I'll just kind of highlight some of the movements there. We have had some changes; I think everybody has seen that on crude oil and so forth. Copper has been moving a little bit up and steal likewise.

We also had some going the opposite direction -- aluminum and nickel. The key for us is and this is pretty consistent the way we have been managing this over the last five or six years now since we have really launched the PPI purchase price index philosophy here and the sale price index. What our goal is is neutrality. Okay? We want to achieve at least neutrality. So when we absorb, have to take raw material increases, we are not trying to make a profit on those increases other than the normal gross margin on those increases.

So what we are trying to do is achieve neutrality. We are trying to keep the purchase price index less than one and the sale price index greater than one. And we are pretty much doing that. We have done that in very, very difficult times. We are doing that today, which is not as difficult environment is what we've seen in the past. We've had to manage through some very, very tough times when raw materials were going almost vertical.

So right now, I feel very comfortable with being able to manage raw material inputs and recovering those. We have -- I think we've mentioned in the past we have had price increases across the board in all of our products at least once or twice a year, either in January or July and that holds true for this year as well. So any adjustments that will be made will be made pretty much at those times or at the contract anniversaries or OEM accounts.

So I feel pretty good. We've got things under control and that is a global statement pretty much around the world because we have visibility of these indices pretty much everywhere that we operate around the world.

So flat for the year, but is the spread changing in the second half relative to the first half, price versus cost?

No, I would say that it is pretty much constant.

And then lastly on capital allocation, Don, you mentioned at the analyst meeting that you had stopped buyback because you were anticipating acquisitions. I was very encouraged to see the one you announced the other day. I am wondering if you could true us up -- is that all that is in the near-term pipeline? Do you move back to buyback near term or are you still optimistic about the deal pipeline and that is where the focus is?

Well, I think what we want to do is -- we do have a number of properties that we are looking at right now, candidates that we are looking at. We are at various stages of discussions with them. I think, right now, our focus is going to be to try to bring some of those in. Some of these have been ongoing for some time now and like I said, it is hard to predict when we are going to finally sign off on these. So I think, right now, yes, we would like to do some more deals. We have some in the pipeline and we think we will get some more to the finish line here in the near term.

On the capital allocation or the cash allocation aside from that when you are talking about share repurchases and so forth, let me just touch on the dividends first. We want to maintain a yield on the dividend at least where we have been tracking here, if not better over time and gradually we want to bring the yield up to the median of our peers.

Now, our peer group is a different peer group than many on the call use for peers, so be careful with that. I want to bring it up to the median of our peer group and we will do that over time. So we want to keep that track record that we have going now for about 55 years of increasing dividends every year.

So in order to do that though, we need to increase our dividend at least at the same rate as we are increasing earnings per share -- I mean net income or greater to actually gain on that yield. So I hope that is clear to you. So we are going to do that. I think the Board is pretty much in agreement with that. We'll do it over time, but we will gradually increase that yield up to the median of our peer group over time and we will have an annual increase in the dividend every year as long as I am around, so I can guarantee you that.

The CapEx we already touched on. The pensions, we are in good shape. We trued that up last year. We are in very good shape; we don't have to do anything on the pension this year. I like share repurchase. Especially when our shares have been depressed like they have been, we'd looked at our value of this Company. I look at -- I am doing acquisitions. I can tell you that my best acquisition has been Parker's stock at the prices we have been buying the stock at. So I would like to do more.

We will evaluate that in line with the activities that we get to the finish line with respect to acquisitions. If we have additional capital and we are able to execute on what I said on the dividends, I will definitely do more share repurchase. I like -- especially at these kind of levels. We are doing about 80 million anyway a year in share repurchase just to cover stock option exercises and that. But I would love to do more. That will depend on what we get to the finish line here on the deals and we will keep you posted on that. Hopefully that maybe sheds a little light on our gameplan.

That covers it. Thanks much.

Thanks, Terry. We are running out of time here, so we will take one more question.

Ann Duignan, JPMorgan.

Hi, guys, how are you? Maybe, Don, you would just touch on what you are seeing in North America from an OEM order perspective. You have got a pretty broad group of OEM customers. I am just interested if you are hearing anything about slowdown in orders on the back half of the expiration of accelerated depreciation in any of your key end markets?

I am really not hearing that in any of the markets that we serve. I think, again, the energy markets have been extremely strong for us here if you look at really what is doing very well in North America and I think that is going to continue on. The mining, oil and gas, power gen and you name it right on down the line, those have been extremely strong.

This whole distribution part of our business, of course, is -- the aftermarket, as I mentioned earlier, has been extremely strong. So no, I haven't heard anything. There was a little bit of softening we noticed in the heavy truck. But, again, you know that that has been running at such high levels; I am not really all that concerned about that long term either. I think that is going to remain a very strong market segment for us. So I am not really getting any feedback from anywhere that there is any dark clouds on the horizon.

Okay. I will leave it at that. I think most of the other questions have been answered. I will take it off-line. Thanks.

Okay, at this time, I will turn it over to Don for just a few closing comments. And before that, I would just like to thank all of you for your participation and look forward to talking to you this afternoon.

Thanks, Pam. I just want to then once again thank everyone that is on the call for joining us this morning. I think we had a real good call, meaningful. Hopefully we shared a lot of information that was meaningful to you.

I would like to also take the opportunity to thank all of our employees. I know we have quite a few employees tuning in around the world and I want to thank them for their commitment to serve our customers, ongoing service of the customers, which are doing a great job of and also for their continuing delivery of this strong financial performance that we are witnessing here with these record quarters, a string of record quarters that we have had and anticipate we will continue to have going forward. And so just really congratulations to our global team for all their hard work and effort.

Just one last thing for those on the call, keep in mind that, even with some of the headwinds we are facing, we have got some tailwinds as well and we still are on track to achieve record performance in fiscal 2012 and should finish up as one of our better years for the Company. So once again, I want to thank everybody for their participation and their continued interest in Parker. And I will say that Pam will be available the balance of the day to take any calls and answer any additional questions that you may have. Thanks and have a great day.

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