派克漢尼汾 (PH) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the first-quarter 2013 Parker Hannifin Corp. earnings conference call. My name is Erica 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 this conference. (Operator Instructions). I would now like to turn the presentation over to your host for today's call, Ms. Pamela Huggins, Vice President and Treasurer. Please proceed.

Thanks, Erica. Good morning, everyone. As Erica just said, it is Pam Huggins speaking and I would like to welcome you to Parker Hannifin's first-quarter fiscal year 2013 earnings release teleconference.

Joining me today is 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 may follow today's presentation with the PowerPoint slides that have been presented on Parker's website at www.phstock.com. For those of you not on the line, the slides will remain posted on the Company's investor information website at www.phstock.com one year after today's call.

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

On slide 3, the slide, as required, indicates that in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers and are posted on Parker's website at www.phstock.com.

Again, to cover the agenda for today on slide number 4, the call will be in four parts. First, Don Washkewicz, Chairman and Chief Executive Officer and President, will provide highlights for the quarter. Second, I will provide a review, including key performance measures of the first quarter concluding with a revised 2013 guidance. The third part of the call will consist of the standard Q&A session and for the fourth part of the call today, Don will close with some final comments.

So at this time, I will turn it over to Don and ask that you refer to slide number 5 titled First Quarter Fiscal Year '13 Highlights.

Thanks, Pam and welcome to everyone on the call. We certainly appreciate you joining us today. I just want to make a couple comments and then we will turn it back over to Pam for some additional detail about the quarter.

First of all, our results in the first quarter largely reflect the impact of the continued weakness in international markets and the softness in North America. And that is particularly late in the quarter and I will talk about that in a minute here.

We were actually ahead of plan going into September, so July and August were actually fairly strong months. We were actually ahead of plan and then we experienced in September a lot of cancellations and rescheduling of orders and so forth by many of our OEM customers as they adjusted to current economic conditions. So that is really what impacted the quarter for the most part. We were ahead and then a lot of these cancellations, rescheduling. We saw a September come in weaker than what we had anticipated.

Considering what happened in these conditions, we have performed well in the quarter, but remain cautious about the outlook, especially going into calendar 2013. And I would just say to keep in mind that we are one of the few companies giving guidance into 2013 due to our midyear fiscal. Our earnings guidance therefore reflects this caution with regard to the global economy in calendar 2013.

Just a few points about the quarter, a little review of the quarter. Our sales were essentially flat with last year at $3.2 billion and they were impacted by a 9% decline in Industrial International sales, so you can see where the weakness is coming from. It is in our International segment. This is the third consecutive quarter in which we have reported a year-over-year decline in this segment, largely as a result of recessionary conditions in Europe and moderating growth then in Asia. So really Europe was impacted the most and then followed by Asia.

That was partially offset by a 5% growth in North America in the quarter. Currency was negative 3% while acquisitions contributed 3% and organic sales were essentially flat. And that combination resulted in a flat top line for us for the quarter.

Total segment operating margins were 14.4%, which were actually pretty good when you look historically. They were pretty good numbers in spite of all of the negative segments that we are talking about here. And were again impacted by the Industrial International segment, which had operating margins of about 12.9% while Industrial North America margins remained pretty strong at 17.9%. I might just point out that North America margins were better than our full-year North American margin last year, which was at 17.2%. So North America performed very well in the quarter.

Net income for the quarter was $239 million(sic-see press release "$239.9 million") or $1.57 per share and that is a decline of 18% compared with last year's first quarter and that EPS reflects additional acquisition integration costs and we will talk about that in a bit, as well as Aerospace R&D expense. I might add there that the additional expense for Aerospace was required to keep pace with our customers' timelines for several of these new programs that we have been working on that we landed over the last couple of years. So that is what impacted the R&D expense.

Net cash from operations was slightly negative, driven by a $226 million discretionary contribution to the pension plan and this anticipated change was announced previously.

During the quarter, we also continued to execute on long-term initiatives to drive growth and profitability. Some of those are as follows. We completed five acquisitions in the quarter, which added approximately $243 million approximately in annualized sales. Additionally, in October, we announced two more acquisitions, two filtration acquisitions and those will add about $141 million in annualized sales.

In addition, we announced the divestiture of the automotive air conditioning portion of the Climate & Industrial Controls segment and sales for that segment that we divested was approximately $140 million in sales. That unit, by the way, was in our numbers for the entire first quarter, but will not be going forward.

Earlier this month in France, we celebrated the opening of our 2000th Parker store. We added 1000 stores in the past five years. We have added a store approximately every business day over the past five years somewhere in the world. So a lot of good things happening from the standpoint of acquisition activity and other growth initiatives for the Company.

Looking forward to our expectations for the full fiscal year, we have revised our guidance for earnings for continuing operations from the range of $7.10 to $7.90 to the range of $6.15 to $6.75 per diluted share and that is basically reflecting what we see right now. As the year unfolds and we get another quarter in, we will have a better look at the next calendar year at that time. I think the elections will be over and maybe some of that -- things will calm down a little bit and we will see what impact that might have going forward. But right now, we felt comfortable going with this range. We will adjust that as we deem necessary.

As a reminder, these estimates include an expected increase in pension expense of approximately $0.35 per diluted share as a lower discount rate was required for accounting purposes. So with that, I am going to turn it back over to Pam and she will get into a little bit more detail for you.

Thanks, Don. So at this time, we will just take a look at slide number 6 and I will begin by addressing earnings per share for the quarter. Fully diluted earnings per share for the first quarter came in at the low end of the guidance at $1.57. This is a decrease of $0.34, or 18% versus the $1.91 from the same quarter a year ago.

And just laying out those components, the puts and takes of that $0.34 for you, segment operating income accounted for $0.26 of the decrease and this is mainly due to international and the continued softness that we are seeing in that region that Don just talked about. Below segment operating income or what we refer to as below-the-line items impacted earnings per share unfavorably by $0.09 and again, this is mainly due to the other category and it is the result of the higher pension costs that we communicated last quarter.

Higher taxes impacted earnings per share by $0.02 and this is mainly due to the expiration of the tax extenders bill for US research and development credits and there also were some discrete items that were an expense this year and a benefit last year. And then last year's outstanding impacted earnings per share favorably by $0.03.

So moving to slide number 8 looking at the top-line revenues for the quarter, they were essentially flat, decreasing $19 million or 0.6% coming in at $3.2 billion consistent with last year. Revenues decreased in International and Climate & Industrial Controls, offset by increases in North America and Aerospace. There wasn't an impact to revenues as a result of acquisitions and currency in total as acquisitions added 3% to sales, which was offset by negative currency of approximately the same amount.

Segment operating margins for the quarter decreased 170 basis points from 16.1% to 14.4%, again, mainly due to International and Aerospace. Please note that acquisition expenses and integration charges are included in these numbers. Parker incurred $0.01 in restructuring charges in the quarter and plans to incur $0.05 to $0.10 in fiscal year 2013 going forward.

Slide number 9, focusing on segments and commencing with North America, organic revenues increased 2% in the quarter. Acquisitions added 3% to revenues and currency was relatively minor in this segment. As such, reported revenues increased 5%.

Operating income increased from $223 million to $227 million, a 2% increase over the prior year. And operating margins of 17.9% for the quarter decreased 60 basis points from first quarter last year. However, you should note that the first quarter of last year was an exceptional quarter with a margin of 18.5%.

Continuing with the Industrial segment moving to International, organic revenues decreased 6% for the quarter. Currency was a deduction to revenues in the quarter of 7%, again, mainly due to the weakness of the euro. Acquisitions added 4% to sales and as such, reported revenues decreased 9% for the quarter. Operating margins decreased 330 basis points to 12.9% and this is down from 16.2%, again, due to reduced sales in Europe, Asia and Latin America and the impact of acquisition-related costs and of course, currency.

And then moving to slide number 11 and focusing on Aerospace for a moment, their reported inorganic revenues increased 9% in the year as acquisitions and currency had minimal impact. Margins decreased 240 basis points for the quarter to 11.4% from 13.8% and this includes the higher nonrecurring engineering charges in the higher OEM business versus aftermarket.

So moving to slide 12, Climate & Industrial Controls. For the quarter, core revenues were down 3% and unfavorable currency deducted another 2%. So as such, reported revenues were down 3%. Segment operating margins as a percent of sales in spite of lower sales increased to 9.4% from 8.2% a year ago.

So now moving to orders, I will quickly run through this for you. Slide number 13 details orders by segment and just as a reminder, these numbers represent a trailing three-month average and are reported as a percentage increase of absolute dollars year-over-year and excluding acquisitions and currency except for Aerospace. Aerospace is reported using a 12-month rolling average because of the lumpiness of that business.

And as you can see from this slide, orders declined 6% for the September quarter just ended reflecting softness in North America, continued softness in Europe, China and Latin America, which resides in the Industrial International segment. North American orders for the quarter decreased 11%, Industrial International orders decreased 8% and Aerospace orders increased 5% for the quarter, Climate & Industrial Controls orders increased 2% for the quarter.

So moving to the balance sheet, our balance sheet remains strong. Cash on the balance sheet at year-end was $436 million and $35 million in commercial paper was outstanding. DSI or days sales in inventory remained at 62 days in fiscal year 2013 versus 2012 and this includes inventory that we added in connection with acquisitions. Inventory to sales of 11.3% compares to 11.4% in the same quarter of fiscal year 2012. So not bad performance on the inventory side. Accounts receivable in terms of days sales outstanding closed at 51 days, three days higher than last year. And the WADPO, or what we call weighted average days payable outstanding, increased to 55 from 54 last quarter.

Operations used cash of $7 million in the quarter mainly due to cash contributions to the pension plans of $226 million. Other major uses of cash in the quarter are as follows -- $169 million returned to the shareholders via share repurchase; $108 million in dividend payments of $61 million; $195 million in cash utilized in connection with acquisitions; and then $77 million, or 2.4% of revenues, was used in connection with capital expenditures. We have been saying for some time that it would get up to the 2.4% level and so we are seeing exactly what we have been talking about for a while. And then net of these uses of cash, there was a positive FX impact of $39 million, so cash decreased $402 million in the quarter.

So on slide 16, here we have the debt to total cap ratio, 25.7% and on a net basis, 20.7%. So we have lots of room to grow through acquisitions and organically.

So now we will move to the guidance, which is illustrated on pages 17 through 19. And on slide 17, the guidance for revenues and operating margins by segment, they have been provided there. I am not going to read through those here on the call, but they have been detailed on the slide for your convenience.

And then on slide 18, guidance has been provided in total for items below segment operating income and that is $480 million at the midpoint. The amount is higher than the prior year, but it is due to the pension costs that we talked about on the last call.

Slide 19 summarizes the guidance on a diluted earnings per share basis and as you can see from this slide, the guidance for fiscal year 2013 for earnings per share is projected to be $6.15 to $6.75, just as Don had mentioned earlier. The components of the changes in guidance have been detailed on the waterfall chart on this slide that you see now, and this is reconciling the previous guidance of $7.50 to the revised guidance using the midpoints of each.

So what you can easily determine is that segment operating income on a per share basis decreases by $1.09 and that is mainly due to the Industrial segment of our business, below the line items at $0.05, tax is a deduction of $0.05, less shares outstanding is a result of share repurchase and adds $0.04.

So just as a reminder, the forecast doesn't include any acquisitions that we may make in the next three quarters of this year. The guidance assumes the following at the midpoint -- increased revenue year-over-year minus 2% or decreased revenue, I should say; segment operating margins of 14.5%; expenses below segment operating income, including corporate, admin, interest and other at the midpoint of $480 million with a band of plus or minus 2.4%; and a projected full-year tax rate of 28.5% and this is up from 28% in the previous guidance and I will talk about that in a minute. And then the guidance includes $0.05 to $0.10 for restructuring, expected to be on the high end. We talked about the $0.05 to $0.10 last quarter and we are now expecting the restructuring to be at the high end of that amount.

But a couple of salient points with respect to the guidance, sales first half/second half are divided 48%/52%. Segment operating income in the first half to the second half is divided 44%/56% and now getting back to the tax rate and why it is going to be higher. The Company will recognize a gain in the second quarter from the sale of the automotive portion of the Climate & Industrial Controls segment. We have excluded that from the guidance due to planned offsets that will occur in the second quarter. However, the tax rate is higher in the second quarter because we needed to add the taxes related to that gain as we don't see an offset in the tax line in the second quarter as a result of the offset.

So you will see in the second quarter that the tax rate is about 200 basis points higher than it is in the third and fourth quarters and again, just to reiterate, that is tax on the gain from the sale of the portion of the Climate & Industrial Controls business that we sold.

Earnings per share will be lower in the second quarter as revenues are lower and again, this is consistent with the natural cycle of our business. We have more holidays in the second quarter and so our second quarter is our, I would say, our worst quarter of the year. That is consistent from year to year for the most part and so don't forget that as you are working your models. The second half of the fiscal year is higher than the first half and again, this is due to the natural cycle of the business. We have a 48%/52% split. So at this time, I think that pretty much covers the guidance and we will open it up to the standard Q&A.

(Operator Instructions). Joel Tiss, BMO.

Wow, I finally made it. Just two quick questions; one is a clarification I guess. Can you be more specific on the accretion or dilution from the sale of the CIC business, the auto part?

Yes, I can. It is about $0.04.

Okay, thanks. And then I just wanted to ask Don -- I mean he is probably the guy with the most experience on the call, unless Alex Blanton is on and I just wondered, you have been through three or four recessions or whatever and you have seen how they've developed and all that. And I just wondered like what do you see for the next year? What are your customers saying? Are we going into another recession or are we just slowing down or correcting inventories? Can you just take your whatever years of wisdom and help us out a little bit?

Thanks, Joel. Basically, if you think back to the end of last fiscal, and when we started talking about this fiscal year, which takes us halfway into 2013, what we were hearing on the street at the time and from our customers and all that, keep in mind that, for instance, Latin America was pretty flat and had been flat for quite some time and we started hearing, well, we are going to start seeing a little bit of a pickup there because we have been down. And on a month-to-month, quarter-to-quarter basis, we are going to start seeing some pickup. We didn't see any of that.

The next thing we heard was that Europe is in the tank, which we knew. Last year, they were -- of course, their whole Greece thing just continues on. I don't know if that will ever be resolved, but it was all that malaise about what is happening in Europe and how they are going to get their financial things in order. And we heard that there was probably going to be some improvement there. We haven't seen any improvement. Actually we have seen actually it has gone the opposite direction.

Then, lastly, as you will recall, we talked about Asia and we said, yes, a stimulus is coming in China, the rail project is going to come back on, construction is going to probably pick up a little bit. And in fact, if you look at our China activity, it really hasn't materialized and as a matter of fact, the GDP over there is more like in the low 7s now as opposed to what they were looking at before.

So as I look forward, do I see a cliff coming? I don't see a cliff. It just seems like a -- just like a flatlining, if you will, waiting for something to happen. It just is -- it is not like what happened a couple years back in '09 when we had the housing crisis and all the subprime crisis and so forth going on. I don't see that happening, but I just don't see any more right now as we were hoping to see some positive movement in any of these markets overseas. And that is -- any of these regions around the world.

So what we decided to do here is just say, hey, let's not assume anything at this point; let's just assume this current situation continues as is. We don't see anything where it is going to like be a cliff going forward, but at least for the rest of our fiscal year, I haven't heard anything that would change my opinion that we are going to change the current picture all that dramatically. Something might happen after the elections. Who knows? It is anyone's guess as to what might happen after November, but we are just assuming that it is kind of flatline from here the rest of the way out and that is kind of the way we are playing it here.

We are taking a number of actions internally to adjust to that reality and we are doing all the prudent things that we have done in the past with respect to our workforce adjustments and CapEx rebalancing and things like that. And we will continue to look at that. So we will get another look at the end of the calendar year, probably have a better vision of the third quarter and fourth quarter then. And I would say based on what we are seeing right now at this point, I don't think there will be much change unless something dramatically happens in one of these regions.

All right. Thank you very much.

Stephen Volkmann, Jefferies.

Hi, good morning. Was wondering if you could just give us a little more color I guess on the North American orders. That was the one that was kind of surprising for me. And Don, you sometimes have your sort of 3/12/12/12 commentary that you do by end market and I am wondering if maybe that might help us understand that.

Well, just -- let's talk a little bit first about just a couple of other indicators. One thing, when you look at -- and I like to look at the PMI indices because that is kind of telling as to what is happening there. First of all, all of the PMIs pretty much globally have been going up interesting enough in spite of what we have been just talking about here. But only North America is greater than 50%. So that is kind of telling as well. So everything seems to be moving a little bit in the right direction, but nothing other than North America is really in a positive territory with respect to the PMI.

When we look at the specific market segments and what is happening there as far as order trends, which ones are doing better and not as good, pretty much all of the Aerospace markets, both military OEM and aftermarket segments, are all looking good on a quarter-to-quarter comparison. That is what I am going to kind of give you here is kind of the overall trend.

Some of the other ones that are looking good, power gen, process markets, farm and ag has been positive and I think that will continue. Oil and gas has been positive and commercial refrigeration, those would be, if we looked at our trends, those would be the positive ones. The ones that are kind of flattening out for the most part, but not necessarily terrible, but it is just that they are not growing at the same rate they had been in the past would be cars and light trucks, distribution, semiconductor, life science and heavy-duty truck. I mean this is not to say those are doing real bad; it is just that the trends are actually flattening out on those.

And then regionally, if we look at the regions as well, as far as the trends, both the 3/12 cyclicals and the 12/12 cyclicals, right now, North America, the 3/12 is a little bit below 100%, which would mean that the North American markets are coming in for a soft landing, kind of flattening out, which we kind of have been seeing here. So the 12/12 is still north of 100%, but heading towards 100% on a year-to-year basis.

Europe is running around mid-90%s on a 3/12, which is basically pulling the 12/12 down into the mid-90%s, so that would be the worst region for us. Worldwide, that is real weak. Asia, we have basically a 3/12 and 12/12 that is just slightly below 100%, so pretty flat. Asia pretty flat at this level. It is flat to slightly negative. Latin America, the 12/12 is running just under 100%, so again it is still weak as well. So really with the exception of North America, the rest of these regions are weak. Europe being the weakest for us. I could go into specifics end markets, but I just wanted to give you that basic color there.

One other thing, just to give you maybe another bit of information, our backlog, this would be our total backlog for the Company, in the first quarter, decreased 2.5% year-on-year. That is for the total Company. That includes Aerospace. If you look just at the Industrial part of the business, the backlog decreased by 8%. So that will kind of give you an indication. Again, that activity or those numbers Pam already covered as to where that was coming from. So hopefully that helps you a little bit.

Great, I appreciate that and maybe just quickly just your thoughts on share repurchase given the liquidity you have on the balance sheet and the cash flow that you seem to be doing this year?

Well, share buyback -- currently, just to kind of remind everybody, we increased our 10b about a year ago, 10b5-1, from about $50 million a year to $200 million, so around a $200 million a year, about $50 million a quarter pace right now, so that will continue. We bought in the first quarter I believe around somewhere around 57 million shares back in the first quarter. And what we would -- that would give you about 107 million in the first quarter total for the Company.

What I have been doing -- not just I, but what we have been doing is really focusing primarily right now trying to keep enough dry powder to go after some of these acquisitions that are in the pipeline. You can see that we picked up five; we have got a couple more coming through in this quarter. So we have been just kind of paying close attention as to are these going to make it to the finish line or not. If they are, we would like to maintain -- have some capacity to do some of these acquisitions. Not all of them we realize are going to make it to the finish line.

And then after that, if, in fact, they don't, we will buy back more shares, but I don't want to predict at this point just what we are going to do. I would say the preference right now because we have been working on some of these acquisitions is to try to get some of these closed in the balance of this fiscal year.

The other things that we are going to do, of course, we are going to continue to do would be the dividend payout. We want to continue that. We have an increase record that goes for 56 years now and we are pretty happy about the yield where it is at. We are approximately at the median of our peer group, around 2% yield and we might need to tweak that a little bit. Of course, if the stock drops further, we won't have to worry; it will be higher than 2% yield, but we hope that doesn't happen.

And acquisition -- not acquisitions, but then other growth areas like supporting capital expenditures. We are still looking at around 2.5% -- I think Pam mentioned 2.5% and we are still looking at that as far as capital allocation.

So hopefully that answers it. I can't give you a hard number on share repurchase, of course. We will look at share repurchase in light of the acquisitions that we are looking at and if we have capacity there and the shares are suppressed, we will definitely do more share repurchase.

That is great. And I don't want to put words in your mouth, Don, but it sounds like what you're saying is the acquisition pipeline is fuller than it has been for a while. Is that accurate or am I reading too much?

I think that is very accurate. It seems like it took a longer time to fill it this time around because we have been talking about it for a long time that we were looking at a lot of things. It seems like the pipe is moving a little -- the fluid is moving a little slower through the pipe, but they are starting to come out the other end, so that is good and it is encouraging because we've picked up some very nice acquisitions of late.

Thank you very much.

Eli Lustgarten, Longbow Securities.

Good morning everyone.

Hi, Eli, how are you?

Good. Just a clarification, your EPS guidance assumes what share count for the year because that's probably the easiest way for us to do it?

About 154.

About 154. So you actually don't expect (multiple speakers)?

I'm sorry, 153. I apologize.

153. You are just about 152.6 I think for the quarter. So you are assuming there is no net share reduction --

That's right. That's right.

-- for the rest of the year --

That's right.

-- under the guidance? Okay. And the guidance for revenue includes the $380 million of annual sales that you have announced --

That's right.

-- in the first quarter, so it is all in there?

That's right. Just so you know though, because -- let me just give you some numbers here in terms of the acquisitions. It is about 2.5%, 2.4%, 2.5% of the sales amount, okay?

Okay, all right. And I mean you are indicating that profitability I guess in -- as the volume comes down, you are going to be able to hold profitability in Industrial in North America for the last year. In other words, you don't expect it to go much under 17% I would suspect for the rest of the quarter despite the lower volumes. And in Aerospace, the increased profitability comes from lower R&D or better volume and better mix or what is --?

Well, in terms of the Aerospace, Eli, it is really both. It is the R&D that Don talked about earlier and just us trying to react to some of the programs that we have won over the last five years and a little bit of a change there in terms of our forecast going forward. And also as --.

How much was the R&D increase in the quarter unexpectedly for

$5 million, about $0.02. And then the other part of the change in the guidance is in the mix and it has to do with the commercial MRO business here. It is not quite as robust as we had planned, slightly down.

And the profitability in both Industrial North America and Industrial International going forward, I guess you are saying it is going to come down to like 17% pretty much in North America and stay the same in International from where we are today?

I would say that North America is staying, Industrial staying north of 17% and International gradually improving throughout the year.

Right. And Eli, one thing to be aware of, the way that we have -- the currency impact, it gets more favorable as we go throughout the year.

Okay. And one final question, we talked about the drop in orders and so can you talk about inventory liquidation at distributors? Are we seeing -- our contacts are saying that we're starting to hear or talk about it. And particularly, construction equipment and -- I am surprised heavy truck was flat because the production was down 20% in the fourth quarter, but is construction equipment taking down their orders also across the board?

Yes, that's the segment that we have seen the most adjustment in is the construction equipment, the OEM segment. A lot of the OEMs readjusting there and I think that is pretty much globally too, by the way. It is not just North America; it is pretty much globally that we are seeing in the construction segment part of the business.

And distributor inventories, are --?

Yes, distributors -- I would say distributors, Eli, probably reacting, from what input we are getting, pretty much like they have in the past, pretty much haven't been building a lot of inventory to begin with, so they are basically adjusting to reality like we are. I don't see any huge material changes one way or the other. I think they are going to be gradually making adjustments as time goes forward. Keep in mind that there is no cliff that we see on the distribution part of the business either. That is still a pretty solid segment for us.

Eli, we need to be cognizant of time to give other people a chance. Thank you.

Okay, thank you very much.

Rob McCarthy, Robert W. Baird.

Hell, this is Mick Dobre in for Rob McCarthy. Good morning.

Good morning.

So first a quick question on Industrial International. Can you give us a little more color on the integration acquisition costs in the quarter?

Well, for the Industrial International segment, we are seeing 3% for the -- $0.03 for the integration and acquisition costs. So this relates to deals that we have announced and completed in Q1. This also relates to deals that are unannounced and that are in the pipeline that Don has been referring to.

Okay, great, thank you. And then switching back to Industrial North America and you commented a little bit about Parker stores, but I am wondering are you seeing going forward any sort of mix shift in the way your revenues are generated in that segment? And what sort of impact did you bake into your margin assumption because, from what I can tell, your incremental margin embedded in the guidance is something north of 35% in North America. So I am kind of wondering is it that you are sort of seeing a more pronounced shift on the distributor side or is it that it is OEM business that potentially carries higher margin there.

I just would like to make a comment about these marginal return on sales at this point. There are certain points in the cycle when you don't have a lot of acquisitions you can look at these marginal return on sales numbers and they make a lot of sense. But then there is points in the cycle, and especially a period like this when we are doing a lot of acquisitions, these marginal return on sales numbers, there is the law of small numbers ,number one and then also, due to the acquisitions, they can become a little distorted.

And if you look at North America, just to give you an example, the margin of return on sales in the first half is, you are right, north of 35%, but if you look at the first quarter and the second quarter, you have a favorable 6% and then an unfavorable 24% in the second quarter. So it is just the way the numbers are working out. For North America, quite frankly, we are right in line where we think we should be.

Okay, thank you.

Alex Blanton, Clear Harbor Asset.

Hi, can you hear me?

Yes, good morning.

Hi, Joel. You asked the question I was going to ask and I want to go back to that for a minute. No one has really focused on the 11% decline in North American orders in the quarter and that apparently really started in September. Was the first two months up in September more than offsetting and what does this mean in terms of the economy for the fourth quarter? What do you think?

Well, let me just give you a little color on how things played out through the quarter. As we went into July and then August, we were feeling pretty good because we were right on pace with what we had told you previously. It is really the month of September that really did take a big decline.

So it was more than offsetting? In other words, it was down more than the first two months were up?

Yes. For the quarter, we can actually look at the miss. We did $1.57 for the quarter. We thought we were going to do around $1.66. It really was attributable to the really tough September month.

Well now business sort of indicate we might be entering a recession here, a big falloff in orders in September and the weakness overall in other companies' results that are coming along here as we go through the earnings season. I am just wondering why you are assuming it is going to be flat for the year when you are starting the next nine months with a big downturn in your orders.

And secondly on that question, how do you think the election is going to affect you? Depending on who is elected, you might have a big increase in business in the second half or a big decline. So are you just waiting to see what happens or do you think it doesn't matter?

Well, maybe, Alex, I will just touch on -- this is Don -- I will touch on the second part. We can't predict what is going to happen frankly. We have our own opinions as to what would be best for the economy and best for our business certainly as to outcomes, but I don't want to go online and predict anything.

I think -- so instead of doing that, we just decided not to predict anything and just say, hey, let's -- we are going to get another look at this after the beginning of the year; we are going to know a lot more then. We feel pretty comfortable with our second quarter. You can back into our second-quarter numbers. We have given you enough information so you can back into that and we feel pretty confident about those.

And when you look at October the way it is coming in right now, I mean October is usually a pretty good month and it is shoring up to be a reasonably good month. So that is going to carry a big portion of the second quarter because remember November, December are the weakest months in the quarter. So had we not had indication of a reasonable October, we would be telling a different story right here. Okay?

Okay, yes, I got that. Okay, listen, I don't want to take too much time, but I have got another question. On your International business, you had a 50% decremental margin. Operating earnings were down $56 million and sales were down $112 million. So why was it so large on the decremental side?

Alex, Jon here, just to try to help you with that internationally first. We talked about the acquisition, integration and acquisition costs, so that $0.03 that we have talked about is baked into those MROs here for Q1. But in addition to that, as you know, we try to manage to negative 30%. That is historically in the best times when we are actually going down, we are able to manage to negative 30%. That provides a very good result from us from a marginal return on sales.

When we first started turning though, as we are turning right now, we can't react instantaneously and so we are furiously, throughout all of our operations, specifically in this case Internationally that we are talking about, working to try to take the actions that are necessary in order to adjust to the new reality that we are seeing here in terms of the recession in Europe, in most countries there, as well as the reduced industrial production indexes that we are seeing from Asia, primarily in China.

So you are managing -- to try to get a 30% decremental margin, but you can't react that fast, right?

Right, right. So we don't expect that 50% to continue and we are determined to get to no worse than negative 30%.

And that 30% would be lower, but you don't want to cut out all of the SG&A that you built up necessarily, right?

Well, we have got a certain base that we will continue to maintain and we will continue to try to structure all of our operating divisions in a way that is going to make us also able to be able to react as things go back up. So we will be mindful of the long term. We are not going to be totally short-term focused.

Okay, thanks.

Andrew Casey, Wells Fargo.

Thanks and good morning, everyone. At the risk of beating a dead horse, I just wanted to ask Joel and Alex's question a little bit differently from a historical context. Could you discuss whatever differences you may be seeing between what happened in September in Industrial North America, the order drop-off from what you historically saw back in fiscal Q2 '09?

Andy, Jon here. One thing that we have been looking at very closely is, and talking about is, of course, as we are putting the guidance together here how does this situation compare to prior years. And we are very intensely looking at the data in each one of our groups in each one of our segments.

One of the things that Don talked about earlier, I think it is very important for you, Alex and Joel and everybody to remember is that we did experience several cancellations from some of our OEM customers and those cancellations, of course, are one-time events. They are not a general pattern. They were enough for us to mention in our comments going forward. And so as we experience those cancellations, they will have a one-time impact on our order rates for a quarter, but we don't see -- especially given the detail that we know behind the order reductions, we don't see that impacting us going forward at the same rate.

So what we do, as you know, is we took our bottoms-up approach in our forecast when we put our guidance together. We feel very good about our Q2 and our balance of the fiscal year based on what we know right now and that is how we basically have looked at this question of the orders in the month of September and the impact on North America for the quarter.

Thank you for that, Jon. So if I could take a stab at recharacterizing what you just said, is your view that the OEM customers in particular who made those cancellations are just taking deep production cuts right now to true up their order boards? Is that --?

Yes, I think that they are resetting -- there is no doubt that they are resetting and we are reflecting that in our results. And keep in mind that, as Don talked about, the PMI moving up in North America, many of our customers that reset their orders in the quarter are also resetting their look to react to the international situation. And sometimes those orders are going to our OEM customers in North America, but ultimately destined for final demand that is international-related.

Okay, thank you very much.

Jamie Cook, Credit Suisse.

Good morning, Jamie. How are you doing?

Oh, this is actually Linda in for Jamie.

Oh, how is Jamie doing, by the way?

She is doing well.

Good. She just had a baby, by the way.

So I mean kind of going with what everyone else has been asking with those orders in the US, I mean those cancellations, how is that making 2013 look for -- calendar year 2013 looking for you guys? Is that -- like the OEMs, are they looking at still a growth year or is that going to be more flat looking or down? Like what is sort of your expectations with your orders?

Well, I think -- this is Don again. I think if we see that happening on an ongoing basis then it is going to bode not so well for 2013. But like we've said earlier, we are seeing this adjustment and I think this is just adjusting like we are adjusting to the current reality and I don't see it continuing, at least at this point. Now if the global condition worsens, then I think maybe there is going to be another readjustment, but I think that is how it will affect us over the long period. I don't see any sustaining effect of what we saw in September above and beyond what we have already indicated in our guidance.

Okay. And then switching over to International then. I mean China seems like it is kind of an important part of the International recovery. What are your thoughts on China? I mean is growth going to come back there next year or is that pushed out to your fiscal year 2014 or how is that kind of looking?

It is Pam Huggins speaking. Really we have become I don't want to say negative, but versus what we were thinking even three months ago, our view is it is somewhat different. We were probably a little exuberant in what we thought might happen in China, but we were right in line with what everybody else was thinking at the time too. We thought we would see more of an uptick there actually now. We do have a little bit of growth baked in, but it is very minor, 1% to 2% in the second half and I would call that probably more in line with the natural cycle of our business than really seeing any true uptick that is going to take place there.

Okay, great. Thanks, guys.

Nathan Jones, Stifel Nicolaus.

Good morning, everyone.

Hi, Nathan.

Can we just talk a little bit about Europe and kind of the sequential progression there? Are things still deteriorating sequentially, stable, getting any better?

Well, I think if you look at what is happening from some of the PMIs that I had mentioned earlier, which is probably the best indicator overall, I mean we can talk about our own numbers and all that, but Europe is negative, I mean negative to 50%. They are down around 45%, 46%. They creeped up a little bit in September. Germany actually bounced up about 3 points, so they are around 47%, which is a good indicator. So I don't think deterioration from this point is what I am seeing here. I just don't see a tremendous uptick either. I just see more of a steady as she goes.

And could you talk about specifically your own business over there and how that progressed through the quarter?

Nathan, as the quarter went on, it was obvious to us that, in Europe, we were bouncing along a low level. And so we don't see further deterioration through the quarter. Our projections through the balance of the year are that we are basically flatlining and flatlining in terms of the growth that we had projected in the first set of the guidance at the rate that we are now seeing and Nathan, we are at a low level there. We have never gotten to the point that we really have been able to see a huge growth in the different end markets that we are in there that are close to some of the other end markets around the world. And we are really focusing in on some of the growth opportunities that are in very strong end markets that are in Europe right now, one of them being oil and gas, process, a few other chemical industries that are really very promising for us. But the short answer to your question, we are at a low level, but we are not deteriorating further and that is what our guidance indicates.

Okay. And it sounds to me a little bit like the dropoff in orders in Industrial North America might be primarily driven by end-market weakness in Asia. Is that a fair statement?

I think that certainly some part of it, some part of that is attributable to that. It is really hard for me to tell you what part of it, so there is -- but that is certainly a material portion of the answer. And again, we are looking at it as a reset and we are looking at our customers reacting to their ultimate demand levels and many of our customers are multinationals too, as you well know.

And if I could just slip one more in on Aerospace, are you expecting the OE versus MRO mix in the balance of the year to be the same, more heavily skewed to original equipment or more heavily skewed to MRO?

As time goes on through the year, it is going to be more heavily skewed to OEM.

Great, thank you very much.

Jeff Hammond, KeyBanc Capital Markets.

Hey, guys. You mentioned a lot of kind of acquisition integration costs, but clearly you are bringing in some good businesses. How should we think -- I mean are these -- do these start to become accretive pretty quickly or I mean -- maybe if we look at the whole year, how should we look -- think about accretion from these deals?

All of these deals that we announced in Q4 last year and in Q1 this year have been accretive, accretive to the bottom line and are performing very well for us. We are very excited about the prospects and of course, we have got integration costs and things, but even given that, these deals have been accretive.

Okay, but your bridge doesn't really call out any acquisition positives or negatives?

No, we just don't get to that level of detail, but -- and we normally don't go deal by deal and explain exactly what the performance has been by quarter. But in general, we wanted to make sure that we explain to you and anybody else that called that these deals have been accretive for us and we are happy with the results that we are seeing.

Okay, and then, Don, I just want to understand the capital allocation dynamics a little bit better because I think what you are saying today is acquisition pipeline is pretty full and we are going to focus more on deals. Yet, the last two quarters, your comments were I want to buy back my stock, I want to buy back my stock and now the stock is down 7% today and it looks like maybe a better buy than the previous quarter. So I mean what is really changing here?

Nothing is changing. It is a timing thing. If I wait -- like I said, the pipeline takes a while to fill. Once you get things going down through the pipeline, it is a timing issue. When those start coming out the other end, I have to have money to pay for them. If they are not going to come out the other end or if they are going to come through slow then I can maybe do some share buyback and replenish my dry powder in the interim. So it is really a matter of timing as far as what I can do and how much I can do when I can do it. We have done a lot of share buyback in the last couple years, I mean $1 billion type number, so it is not like we have been sitting here doing nothing. We weren't able to do as many deals in the last couple of years because we were filling the pipeline, we are looking at things, we are turning some away, we are looking more seriously at some.

So I think it is really a timing issue and we look at this kind of real-time all the time like, okay, how much money do we have, what is our leverage. We are not going to let our leverage go above 37%. We are going to maintain our A ratings on our debt. So what can we do and how much can we do, when can we do it?

Of course, if I knew that the stock was going to drop $7 today, of course, this would be a great buying opportunity and it is a great buying opportunity. And I am not going to predict anything here, but I would say that we are certainly looking at that in light of everything else that we have got coming through the pipeline.

But once I get things going through the pipeline, and I get them going through at a due diligence process, I can't just shut that off. I mean it would be silly to do that. We spend a lot of money to get them to that point. So we have got to continue through with the ones that we are looking at seriously. And we are always looking at Parker's stock as a good potential acquisition for us. And certainly at these levels that it is at now, it is a tremendous opportunity.

Okay, thanks.

We will take one more question at this time, please.

Henry Kirn, UBS.

Hey, good morning, guys.

Hi, Henry.

How quickly can you flex production? Could you discuss a little bit the changes to your headcount plans over the last quarter? And then maybe if the OEMs were to switch back to a more positive view, how quickly could you shift the production back up?

That is a good question, Henry. I think one thing that we are doing is adjusting the workforces globally. It is slower in Europe, probably the slowest of any region around the world is Europe because of all the works consulate negotiations and the government negotiations that go on when you are trying to reduce workforce or adjust it down. And so what we have done over time is we have built up a layer of what we call associates, part-time employees and so forth so that we could flex better. And that is what we are kind of working into right now is these associates where you can take actions a little bit quicker and adjust a little bit faster and yet not eat into your core workforce. So that is kind of what we are working on.

The other thing that we have done as we have gotten some locations we have shortened work weeks. Again, every facility -- we have 350 facilities, so every one is in a different state as far as demand and order trends and so forth. So they are adjusting with short work weeks, part-timers and associate workers and so forth. Those are the kind of things we are doing in the workplace.

I think we are going to be in a tremendously good position to rebound whenever there happens to be a rebound and hopefully, that is soon here. There is certainly a possibility it could be soon. So we are ready. We can add people back. We have got the core workforce still there so that we can respond quickly to any changes in demand.

Okay, at this time, we would like to end the formal Q&A session and I'm going to turn it over to Don who just has a few closing comments. But for those of you on the call, I just want to say thank you. I know that you guys have had a very busy day today, a lot of people releasing earnings this morning. So thank you for taking the time to attend our call and with that, I will turn it over to Don.

Well, I want to once again thank everyone on the call for joining us this morning. I also want to take the opportunity to thank all of our employees, as I have in the past, for their continued commitment and our success. The team continues to execute on our win strategy and they continue to outperform and perform extremely well vis-a-vis our peer group.

Throughout this period of uncertainty, we are going to continue to manage our costs. As we have said on this call, we are going to maintain our strong financial position as I stated with our leverage and we are going to continue to pursue our long-term growth strategy and we talked about all of those issues today.

So I want to thank you again for your participation on the call and for your continued interest in Parker. As we have said in the past, Pam will be here the balance of the day and she will be taking calls. And if you have anything that we haven't answered, feel free to give her a call today. Thank you very much and have a good day.

Thank you for your participation in today's conference. This concludes the presentation. Everyone may now disconnect and have a great day.