派克漢尼汾 (PH) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2013 Parker Hannifin call -- earnings conference call. My name is Stephanie and I will be your coordinator today. At this time, all participants are in listen-only mode. Following the prepared remarks, there will be a question-and-answer session. (Operator Instructions). As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today, Ms. Pamela Huggins, Vice President, Treasurer. Please proceed.

Thank you, Stephanie. Good morning, everyone. This is Pam Huggins speaking, just as Stephanie said. I would like to welcome you to Parker Hannifin's second-quarter fiscal year 2013 earnings release teleconference. Joining me today is Chairman, Chief Executive Officer and President, Don Washkewicz and Executive Vice President, 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 online, the slides will remain posted on the Company's investor information website one year after today's call.

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

This 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, again at phstock.com.

To cover the agenda for today on slide number 4, the call will be in four parts. First, Don Washkewicz, 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 concluding with the fiscal year 2013 guidance. The third part of the call will consist of our standard Q&A session and for the fourth part of the call today, Don will close with some final comments. So at this time, I will turn it over to Don and ask that you refer to slide number 5 titled Second-Quarter Fiscal Year '13 Highlights.

Thanks, Pam and I would just like to extend a happy new year to everybody on the call. We certainly appreciate your participation today. Just to make a couple comments and then we will turn it back over to Pam for a little bit more detail on the quarter.

As we explained last quarter, the second quarter traditionally is our weakest quarter and that is pretty much how it played out this year as well. Sales were essentially flat year-to-year; however, the real key for the quarter, what to remember here, and this is kind of if you boil everything down what happened, is that the organic growth was down 4% and then that was offset by acquisition growth. So we are losing some of the higher-margin business because that business was down and we are picking up acquisition business, which was going through an integration phase so the margins are a little bit compressed and that really explains in a nutshell what happened pretty much in the quarter.

Weakness is still being seen in the Industrial International segment in pretty much all regions. December, in particular, was weak from midmonth on as a number of customers we noted, and this is true both in North America and rest of world, held back on purchases and shipments. So about midmonth, everything kind of stopped in December. In anticipation of a better second half, the earnings guidance for fiscal year 2013 is going to remain the same as we communicated to you last quarter.

Just a couple other comments on the quarter. Net income for the quarter, as you could see, was $181 million or $1.19 per share and that was within the range of guidance that we provided last quarter. Our guidance was $1.10 to $1.20. So we are in the range.

The year-over-year decline in earnings per share reflected continued weakness in Europe, Asia and Latin America, as I indicated before and then this number is also a reflection of the R&D investments in our Aerospace business, as well as a lower margin during integration and acquisition versus organic growth. So that was really kind of to sum up the quarter what was happening.

We are continuing to do extremely well on cash flow. As you can see, we generated $354 million in operating cash flow in the quarter, or 11.6% of sales. So when you compare that to last year, last year was 8.2%. So you can see that we are doing a very good job on cash flow management in the Company.

We are trying to be proactive during this period to adjust budgets to our outlook for the period ahead and we will discuss this certainly further on the Q&A section if you want to get into that a little bit further as far as other specifics that we are doing in adjusting our cost base and so forth in line with our go-forward forecast.

I thought it would be good maybe just to review some of the interesting exciting long-term initiatives that we have that is going to continue to help us grow and drive the future growth for the Company. We announced three acquisitions in the quarter and that will add about $246 million in annual sales for the Company. That makes this year eight acquisitions total that we made totaling about $0.5 billion in additional sales. Now keep in mind, as we said before, those will be compressed margins on these businesses until we get them fully integrated. We are going to have some integration expense in this early period, but, as you can see, that will accrue to us additional sales in the future and all of these businesses are very good businesses.

I will make a comment on just a few of those. We acquired Velcon Filters and that brings us a leadership position in aviation and industrial fuel filtration. This was a very nice acquisition. We acquired a company called Sea Recovery and that supports our water purification strategy, growth strategy and also, we acquired a company by the name of PGI International, which strengthens Parker's position in oil, gas and in general instrumentation markets. So several real nice companies that we are able to bring on board that are going to accrue to us some very good sales activity in the future.

Also, I would just remind everybody, we talked about this in the past that we did divest the automotive air conditioning portion of our Climate and Industrial Controls group and that was finalized and that business was acquired by ContiTech AG. We discussed that a little bit last quarter.

Also, in the quarter, we announced an important joint venture with General Electric Aviation and that was for the development and manufacture of commercial aircraft fuel nozzles to support current, as well as future GE engine platforms. And I think -- we are pretty excited about this joint venture. It is going to result in some really neat state-of-the-art products and nozzle technology for the future. And that is going to bode well for us going forward. It is going to be a great partnership there.

As a validation of the performance of our energy recovery technology, and we have been talking to you about this for quite some time, it has been a long time in development, but it is a tremendous technology. We received additional orders for 29 what we call our RunWise advanced series hybrid drive systems and this would be for refuge vehicles for Miami-Dade County. They were our beta test site, so they tested the initial units and we are very pleased that, with the savings they saw, savings in the neighborhood of 40% to 50% fuel savings, and decided to place additional orders and I think the game plan there, at least in that area, is for them to replace their whole fleet over time with our new technology. So that is pretty exciting. We have got activity going on elsewhere, initial activity and dialogue going on trying to get additional interest in this technology. So it is just a matter of time; this is going to continue to grow for us going forward.

Also, we announced an exclusive technology agreement with Vanderbilt University to develop, manufacture and sell an exciting new product that really enables paraplegics to walk. So if you are paralyzed from the waist down, we have got -- it is currently called Exoskeleton. It is going to be renamed here as we go toward a product launch. But it enables the paraplegics to get up and walk, which is something they haven't been able to do, which is pretty exciting.

A 2014 launch date is planned for that product and that will be the first launch in what we call human motion and control in the Company and we just, in addition to that, to add to the support for this technology, we established a chair in human motion and control at Cleveland State University to help advance this technology in this area in the future. So we are pretty excited about this being kind of what I would refer to a little bit as the final frontier is human motion and control for our technology.

With the current economic environment as it is, we are maintaining our fiscal 2013 guidance for earnings in the range of $6.15 to $6.75 per share per the press release. As a reminder, and I think everybody knows this, compared to last year, we do have an additional pension expense in these numbers of about $0.35 per diluted share.

So with that, that is a quick update on the quarter. We will get into more detail. I am going to turn it back over to Pam now for a little bit more detail on the quarter.

Thanks, Don. So at this time, if you'll reference slide number 6, I will begin by addressing earnings per share for the quarter. You can see the fully diluted earnings per share for the second quarter came in at $1.19 and this fell within the previously provided guided range. This is a decrease of $0.37, or 24% versus the $1.56 from the same quarter a year ago. And laying out the components of that $0.37 decrease in earnings per share versus last year, just let me give you the puts and takes. Decreased segment operating income accounted for $0.34 mainly due to Industrial International and the continued softness that we're seeing in that region and that is in Asia, Latin America, as well as Europe. Higher taxes impacted earnings per share by $0.05 and this is mainly due to the geographical earnings mix around the world and a higher tax rate as a result of the tax on the gain from the sale of the CIC business that Don just mentioned. And then there were less shares outstanding impacting EPS favorably by $0.02 and obviously due to the share repurchases that we made in the quarter.

So moving to slide number 8 now and looking at the top line, reported revenues for the quarter, they were fairly consistent with last year at $3.1 billion, rounding that is and at the segment level, revenues were down in Industrial International. However, that revenue was offset by increases in Industrial North America into Aerospace. Acquisitions added 4% to revenue and this was offset by a 3% decline in the base business and we did have a slightly negative currency impact of just 1%.

Segment operating margins for the quarter, they decreased 220 basis points from 14.2% to 12% and this was across all segments except CIC. Please note that acquisition, divestiture and integration and related expenses are included in these numbers. Parker did incur $0.02 in restructuring charges in the quarter and we plan to incur $0.07 to $0.10 in the remainder of the year.

So let's move to slide 9 and focus on segments, commencing with North America. Here, you can see that organic revenues decreased 4% in the quarter; however, acquisitions offset that by adding 5% to revenues. Again, currency relatively minor. So as such, reported revenues increased 1%. Operating income decreased from $196 million to $184 million and that was a 6% decrease over the prior year. Operating margins of 15.4% for the quarter decreased 120 basis points from the second quarter the last year. And I am not going to go into why that happened. Don just mentioned -- I think he summarized it pretty nicely.

So moving to slide 10, and continuing with the Industrial segment moving to International, organic revenues decreased 7% for the quarter and currency here was a deduction to revenues in the quarter of 2% and that is again, as always, mainly due to the weakness of the euro.

Acquisitions added 5% to sales. Reported revenues decreased 4% for the quarter and operating margin decreased 300 basis points to 10.6% from 13.6% due to the volume reductions, as well as the acquisitions.

So moving to slide number 11, Aerospace, the second quarter reported inorganic revenues increased 7% in the quarter and acquisitions and currency had minimal impact. Margins decreased 430 basis points and this includes the higher nonrecurring engineering charges that we have been talking about and the higher OEM business versus the aftermarket.

So let's go to slide number 12 and CIC. You'll see on this slide it indicates that core revenues were down 19%, but that is really not the case. As you recall, there was a divestiture in the segment this quarter. The prior-year number will not be restated due to the materiality. So when you really restate, what you will see is that revenues are essentially flat. So please keep that in mind as you are looking at that number. Segment operating margins as a percent of sales increased to 4.8% from 4.7% a year ago.

So now moving to orders and consistent with what you saw in the press release, but just to remind you, these numbers are trailing three-month average and they are reported as a percentage increase of absolute dollars year-over-year and they do exclude acquisitions and currency except for Aerospace and Aerospace excludes acquisitions and currency as well, but it is on a 12-month rolling basis.

So you can see from this slide that orders declined 2% for the December quarter just ended, continuing to reflect softness in North America and Europe, Asia. North American orders for the quarter were down 6% and this is an improvement over 11% last quarter. Industrial International orders decreased 5% and this is an improvement over last quarter as well. Aerospace orders increased 14% for the quarter and in CIC, orders increased 1%.

Okay, let's move to the balance sheet and as you well know, Parker's balance sheet continues to be very strong. Cash on the balance sheet at year-end was over $498 million and $282 million in commercial paper was outstanding. DSI or days sales in inventory was 66 days. This is up versus last year's 63, but do remember that this includes inventory in connection with acquisitions. Accounts receivable in terms of DSO closed at 48 days consistent with last year. We are very happy about that. And then Parker continues to make progress on the weighted average days payable outstanding.

So working capital, as you know, Parker does very well as things -- when things slow down. We manage the working capital very well and as Don talked to, cash flow was remarkable in the second quarter. Cash flow, we generated $354 million from operating activities. That represented 11.6% of sales. Some of the uses of the cash in the quarter, $427 million utilized in connection with acquisitions, $64 million utilized in connection with capital expenditures and then, of course, we returned $112 million to the shareholders via share repurchase and dividend.

So on slide 16, moving to that slide please, you can see that the debt to total cap ratio is 25.7% (sic -- see slide 16 -- 27.5%) and on a net basis 22.2%. So Parker does have the ability to continue to grow through acquisitions and organically.

So now I will move to the guidance. The guidance is detailed on page 17 through 19. I am not going to read these numbers to you here on the call, but they have been detailed on this slide for your convenience.

So let's move to slide 18. And you can see that below-the-line-items, we are projecting $466 million at the midpoint and as you know, this is higher than the prior year again due to the $0.35 that Parker is incurring for pension costs as a result of the lower discount rate. We are projecting a tax rate of 28% for the year and that is down from 28.5% last quarter.

So moving to slide number 19, this summarizes the guidance on a diluted earnings per share basis and as you can see from this slide, the guidance for fiscal year '13 remains the same. $6.15 to $6.75 is the range with the midpoint at $6.45. The components of the changes in guidance have been detailed on this waterfall chart for you. Reconciling how we get to $6.45, but it details the changes that have occurred in the quarter. And what you can easily determine is that segment operating income on a per share basis decreases by $0.16 and this is mainly due to Industrial International segment and Aerospace research and development and the continued mix of OEM versus MRO.

Other expense is up by $0.08 and that is really the result on the gain on the sale of the CIC business that we divested. And then tax adds $0.04 and that is the result of the passage of legislation regarding the US research credit. We also have less shares outstanding because of our share repurchases. And please remember that the forecast excludes any further acquisitions or divestitures that we may do in fiscal year 2013.

So just to give you a little more flavor. The guidance assumes the following at the midpoint -- increased revenue year-over-year basically flat, segment operating margin of 14% and then again below-the-line-items of $466 million with a band of plus or minus 2.4%, projected full-year tax rate of 28%, which I just mentioned and then, of course, $0.07 to $0.10 in restructuring.

But a couple of salient points that I want to get across here with respect to the guidance. Sales first half/second half are divided 48%/52%, 48% in the first half, 52% in the second. Segment operating income first half/second half is divided 45% first half, 55% second half and then the EPS will be lower in the third quarter versus the fourth quarter with a split between third and fourth quarter of 45%/55%. So at this time, I think we will commence with the Q&A and thank you for listening.

(Operator Instructions). Jamie Cook, Credit Suisse.

Hi, good morning. I guess two questions. One, if we look at your guidance for North America and for International, you have taken your revenues up a little. Relative to your previous forecasts, the margins are down a little. I am assuming the decline in margins is a result of acquisitions. Can you confirm that and tell us how much the acquisitions are hurting?

And then I guess can you just talk about your comfort level with improving margins on a sequential basis? Is it just based on volumes or are there other potential tailwinds that you have to make us feel comfortable? I don't know if material costs are more of a benefit. I don't know what your assumptions are on FX or mix. If you could just sort of walk me through that. Thank you.

Okay, just to clarify though, at the midpoint, last guidance to this guidance, we did take North America up in revenue, but on International, we did take revenue down, okay? And then you are exactly right, Jamie. To your point, we did take segment operating income down in North America and International. Jon, do you want to --?

Yes, I mean, Jamie, just to the point here first in terms of the headwinds and the tailwinds. From a pricing and a supplier standpoint here, we are staying about even. So nothing really different to report there. At this point, it is a tough pricing environment out there and it is a very important transitional timeframe here for us in the second half as we start to see sequential improvement in our margins going forward here, which we will be looking to our suppliers to help us with as time goes on.

Now, in North America, that is also being impacted by the acquisitions and as Don alluded to earlier, the margins are being impacted by the reduced organic sales being replaced by acquisition sales. And those acquisition sales are coming in at lower margins than we were seeing on the organic business. That is moderating as time goes on.

But --.

I'm sorry. Go ahead.

No, go ahead. Go ahead; I will let you finish.

And then the restructuring that Pam was talking about that we are going to be doing in the second half is also going to be impacting our margins going forward here, including the integration costs too. So that is I think in a summary the way that we are looking at margins going forward here for the second half.

And I'm sorry. That was my bad. You did take your margins down, but I guess -- I am sorry -- Jon, can you quantify how much the acquisitions are hurting?

I can do that for you, Jamie --.

And then again just to clarify. So it sounds like -- I mean we are assuming margins improve in the back half sequentially versus first half. So, Pam, is it just based on volume because it doesn't sound like material costs --?

Yes, well, let me give you a couple marginal return-on-sales numbers without the acquisitions that I think might help. North America, for the second quarter, while the margin return on sales was unfavorable, if you exclude the acquisitions, you are within 30%. You are around 30%, which is what our target is.

International the same thing. If you exclude acquisitions, not quite as good as North America, but it is in the 40% range. So we are -- we are very cognizant of that and it is typical with acquisitions when they first come in, we have all these charges in the first 12 months. So we will work our way through these. These are good acquisitions that have good margins and it just takes 12 months to get there.

Okay, but, Pam, just to clarify, so the margin improvement back half versus first half, it is all volume?

(multiple speakers). We are being cautious at this point in time. We have a 48%/52% split in our guidance, which is pretty much the natural cycle of our business.

Okay, all right, great. I will get back in queue.

Josh Pokrzywinski, MKM Partners.

Hi, good morning. First, just a follow-up on Jamie's question. What is the incremental restructuring spend quantified in current guidance versus prior? I just want to make sure we are clear on that. I know you don't exclude it from guidance, but maybe it would be helpful in kind of understanding the margin lift.

Josh, in total, for the year, we only did $0.02 in restructuring in Q2. We are keeping -- we are moving up to the high end of the numbers that we gave to you earlier, which is $0.10, which is in -- and we have got a range of $0.06 to $0.07 here in the second half.

So that $0.06 to $0.07 is incremental versus the last time we spoke a quarter ago?

Well, the last time, we said $0.05 to $0.10, but we were thinking that it was going to get to the upper end of that and now we think that it is.

Okay, so maybe a fair way to look at this $0.16 segment drag is an extra nickel of restructuring and some integration charges and maybe half of that $0.16 is core business deterioration?

Yes, I think that is fair. I think that is a fair analysis. That is not bad at all.

Okay. And just thinking about cadence through the quarter, obviously, October was pretty bad from when we spoke last quarter. Can you give us a sense of how things fared in November and December just on an orders basis? I understand that December you see shutdowns and things tail off at the end of the year, but it seems like minus 5% and minus 6% in the Industrial businesses inclusive of that rough October, it seems like it would of gotten maybe even close to flat by the exit rate.

Well, let me just give you a little color that I have, okay and then Don and Jon can add on if they would like. But when you look at the North American orders, I mean obviously December was a weak month, but December is always a weak month for Parker Hannifin. It is really difficult to get any read from orders by looking at the December. But what I will tell you is that, in North America, the trough was really in August and September. So when you look at the percentage decline year-over-year, the trough really took place in August and September and obviously getting better from there.

On Europe, we actually saw some sequential improvement in the second quarter. Asia continues to be pretty weak for us. I am hopeful that we are going to see something as we move out and I think everybody else is hopeful and I think, in January, we are even a little more hopeful of that. But December quarter end, it was fairly weak. Latin America, we saw improvement over the prior year. You can see that is up 7%. So we are seeing improvement there as well. And then, of course, Aerospace was remarkably strong in the quarter. Does that help, Josh, a little bit?

That does help. So I guess just to summarize, sequential improvement off of those August/September lows and maybe sequentially flattish in Asia if I am reading that right?

I think that is a good read.

Okay, I appreciate it. Thanks, guys.

Alex Blanton, Clear Harbor Asset Management.

Good morning. I would like -- I have got two questions. The first one is I would like your opinion on the thought that now that uncertainties in Washington are slowly getting resolved that job creators, entrepreneurs and job creators who have been holding back now for four years while their cash and their borrowing power accumulates holding back because of the uncertainties would finally decide that enough is enough and we have got to get going with our plans and get going with our replacement capital spending and get on with life. And for that reason, without too much happening down in Washington, job creation and economic growth will pick up in 2013 as we go through the year and be surprisingly strong. What do you think of that proposition and have you seen any sign of that in your businesses?

Alex, this is Don. Good question and I wish I had a good answer for you, to be honest with you. When we look at our business, if you just kind of look regionally, we kind of look at our order trends because that would give us the best indication of what is going on, our 3/12 and 12/12 activity levels. If you look in North America, we see a slightly improving 3/12, but our 12/12 curve is heading toward 100%, which would indicate very moderate slow growth continuing at this point. So not a catastrophe on the horizon, but nothing hugely different from what we have seen here in the last quarter or two. So that is the way I would read North America right now. And maybe it is still a little bit early to really see the impact of what happened with the fiscal cliff fiasco and all that. So maybe that is yet to come.

Europe is really in the tank. I mean I don't know how else to put it. Our 3/12, we saw a little bit of an improvement there. That is the last three months orders over the previous year three, but it is just kind of approaching 100%, but the 12/12 curve has been under 100%. In other words, the orders are tracking under the prior-year 12/12 month period and that continues. So they are definitely in recession in Europe; there is no question about it. Been in recession and I am not sure just -- with the minor increase in the 3/12, I am not sure when we are going to really dig out of that over there. So we are basically taking actions there, restructuring things and trying to get our costs in line to basically deal with this for the long term if it continues. So Europe not as bullish.

I think Asia, I think we are just going to have to get used to living in a region that is going to be more 7%, 8% growth instead of 12%. So our 12/12 dropped, it is negative year-over-year, but that is because I think, and as you have been reading about this, there is so much happening that the region is settling down into some maybe more realistic and normalized growth rates. So that is not necessarily bad and I think that we have gotten some near-term indications that there is a little bit of pick up there. But I don't think we are going to get back to the 12% levels that we have seen before.

And likewise, I think the same would hold true for Latin America, still pretty flat. We don't see anything tremendously changing over there. So all in all, that kind of adds up to very modest growth. I mean positive overall, some regions being worse than others, but very modest growth. I think what you are asking about is going to remain to be seen if that really takes hold and we see some more enthusiasm as far as investments. I would say in the next month or two, maybe we will see a little bit of change there.

If you asked me what would make the future better, what do I think might be happening out there that might be improving, I think we have been hearing a little bit about housing starts starting to turn up. I think that is a positive, a little bit of a positive indication that commercial construction for instance is starting to see some improvements, as well as heavy-duty trucks. I think there will be a little bit of a rebound there. That is been trending negative there for some time.

Consumer spending, the latest reports on consumer spending that we have been hearing has been more positive. One of the toughest markets we deal in, because it goes through some wild swings, has been the mobile equipment market and they went through destocking and postponement and order rescheduling, all that activity and I think all of that is in the past now. So I think that is a positive for the future, that the construction piece of this business, mobile piece, let's call it mobile, will trend a little bit better going forward.

And then the other thing is, for us, obviously, the acquisition, the tailwind we are going to get from the acquisitions is positive. But overall, the last segment that maybe I would comment on would be Aerospace. We have got the biggest backlog in our history in Aerospace. So it is the largest at any point in time that we have ever had in the past.

I don't want to sound too negative here on looking at the near-term things going on, but I think if you look out a few months, I think you can see there may be some light at the end of the tunnel with some of these other areas showing signs of improvement.

In that regard, just a clarification on your forecast for the second-half earnings per share, I believe Pam said the second half would be divided third quarter 45%, fourth quarter 55%. Is that correct?

That's correct, Alex.

So mathematically, using the midpoint of your range, $6.45, that says that the third quarter would be $1.66 in the fourth quarter, $2.02, to get that split. That is a big increase quarter-over-quarter. What is the reason for it?

Yes, I think, Alex, you are right. I have a couple pennies different than what you have, but you are right on. I see you are doing your homework there. So good for you. Like I said, based on what Don has said, we have basically kept our guidance in line with the natural cycle of our business, the 48%/52%. So while it does incorporate some sequential improvement in International, I think if you look at each region, yes, we do have some sequential improvement, but it is more in line with what we would see at this time -- in the cycle of our business at this particular time. So we are not going way out there, but we think that if we just do what is very normal for us, we will be able to get that type of increase.

Okay, thanks.

Mig Dobre, Robert W. Baird.

Good morning. I guess my first question going back to Industrial North America, can you give us any color on performance of different key verticals, meaning hydraulics versus filtration and automation and how you have sort of seen orders develop through the quarter in each one? Is there a difference between these?

I think, as Don just indicated here, sequentially we are up slightly in terms of our comparisons to the prior year in Q2 in those markets. Again, with less work days in Q2, the change was not dramatic. Going forward in all of those vertical markets that we are talking about, I think the things to keep your eyes focused on here is the, as Don mentioned, the residential, the commercial air conditioning, the construction equipment and we continue to see good progress being made in heavy-duty trucks. So I think that all of those markets in North America are trending better. Mobile not as bad as it was, but certainly not to where we were 18 months ago. So I am hoping that kind of gives you a little bit of color as to how that guidance was put together. Keep in mind, we are up sequentially in North America in Q3 and then up sequentially in Q4.

And just to add onto all the other comments that we have made, keep in mind also as you are looking at the data for us that increase as we move forward here sequentially that Alex was referring to that may look a little sporty at this point includes acquisitions that we did in Q2 and acquisitions that we did in Q1 also. And so by adding that on in the middle of Q2, we are going to see a dramatic effect in terms of our increases in the second half vis-a-vis the first half. So that 58%/42% we feel is very achievable and that is why we did the guidance the way that we did. So I hope that helps.

No, it does. Thank you. And looking at Aerospace too, maybe just a reminder for me, the impact of the incremental R&D on the margin, trying to separate that versus just the mix shift in MRO versus OE in there.

Could you just repeat the question?

I am trying to figure out exactly how large the headwind from these incremental R&D expenses is from a margin standpoint for the Aerospace (multiple speakers).

Okay, yes, it is an important headwind. I mean there is just no doubt about it. We are at the high watermark now in our Q2, which is generally our lowest volume month. So it just hit all at the wrong time for us. So we are clearly at a high watermark in R&D in Q2 in Aerospace. We are projecting to go down in Q3 from Q2 and then down again in Q4 from Q3. We were over 11% in Q2 and we are trending down towards 9% and then 10% for the whole year. And Don, let me ask you if you want to comment further?

Yes, there is just a couple of extra comments I might make on the R&D spend. One of the challenges that we have had there is, first of all, just the number of new programs that we have. The good news is that we have got a number of these programs in the air now. The G650, that has been launched. The Legacy took its first flight, that is the Embraer Legacy and the Rolls engine was certified.

So the good news is and the reason why we can tell you that the trend is going to be down from here is because we have got some of these major programs now, which frankly going into these programs, these are all new technologies, fly-by-wire technology, for all these platforms is extremely complicated and it is hard to predict frankly and we found that it is impossible to predict the cost because you run into all kinds of challenges in putting these systems together because they truly are state-of-the-art.

But having said that, the good news that would give us confidence on the go-forward is the fact that several of these now are launched and that is extremely important. What we are working on feverishly now is the Bombardier C Series and the Comac 919 and the A350. We have got several of those and that is the reason why we are still going to have a fair amount of R&D expense going forward.

And the other thing is just the tone in the marketplace is such that if you delay the launch of an aircraft today, that has very, very bad connotations with the customers and so everyone gets a little bit gun shy of placing orders with you based on promises that you are going to make that very likely may be missed. And we know that there has been some big misses in the market with the new technologies as far as launching these planes. So it is really critical that you get your plane up and out and service first flight when you say you are; otherwise you are going to have a real problem on the order side of the equation. I am talking about our end customers now.

So what impact does that have on us? A lot of pressure to expedite R&D parts of the projects where almost on a daily basis, and there is burndown tables and charts as far as different activities that have to happen within certain periods of time and that is all going forward. So there is a lot of pressure and that has taken a lot of resources from us. I mean we have hired additional people to support that. We are going to support the customer every possible way we can to get these platforms launched promptly. I think that is going to help the customer certainly; that is going to help us in the long term. I think that is going to help all the supply base in the industry when we do that. But that is what we have been faced with.

So as tough as it has been to give you a hard number on R&D, it is tough because every day something changes and a lot more resources have to be put on certain parts of these systems to really stay on a very, very tight schedule. So hopefully that is a little bit helpful for you too to see what is going on behind the scenes.

Yes, absolutely. And the last point here is, as we are thinking about 2014 for instance and beyond, based on the visibility that you have today, should we continue to expect rather normalization of R&D or levels similar to what we have seen in the -- (multiple speakers)?

I think based on what I am saying, some of the new programs that we are working on right now, the ones that were launched, of course, that is behind us. The ones that we are working on now -- the list is getting reduced very nicely here over time. So we would expect that we would level out at some normalized level of R&D. I think we are probably going to always be looking somewhere in the 8% range probably give or take a little bit on that, but it won't be in the 12% plus or 10% plus range like we have seen here. This has just been a very extraordinary activity level for us on these new programs.

But again having just set a record on our backlog in the Aerospace group, that is pretty exciting going forward. So I think, like Jon said, we are at the high watermark and as that weans down and the activity -- the actual shipments start going up, I think we are going to be enjoying the fruits of all this expenditure here in these last few years.

Thank you.

Andy Casey, Wells Fargo Securities.

Thanks a lot. Good morning, everyone. On the revenue trends, the revenue split for the second-half midpoint pretty much suggests Q3 3% year-to-year decline, Q4 up 4% to 5% year-to-year. I am trying to make sure we interpret that year-to-year inflection correctly. And you answered some of this with respect to the prior questions about mobile market anticipated improvement, but is there anything else included in the top-line assumption like absence destocking or something like that that occurs in Q3, but not in Q4?

No, I think the delta in the Q4 versus Q3 is just the continued slight moderate improvement that Don was talking about in his earlier comments, moderate, good moderate improvement, not only in North America with some of the end markets that we talked about, but although Europe is on the bottom here in recession, it is not -- we are not projecting another leg down. We are projecting a moderate increase there. And of course, in Asia, we have got some added growth built in as the year goes on. The last year, as you know, was for them the weakest in China in particular, the weakest year in 10 years in terms of industrial production but that is now projected to bounce back up just oh so very slightly here for us and we are starting to see some early signs of that as Pam alluded to earlier too here.

So yes, there is not -- we are really taking a look at every market, every region and getting reports every month from all of our people and this is the way that we see the Q3 versus Q4 trend going here in each one of our segments. So it is really that simple.

Okay, thank you, Jon. And then lastly kind of a clarification on the 28% assumed tax rate. Does that include or exclude the impact of the $0.08 and the 30% plus in Q2?

Yes, it includes it, Andy.

Okay, so second half much lower than first half basically?

That's right.

Okay, thank you very much.

Eli Lustgarten, Longbow Securities.

Good morning, everyone. Just a couple clarifications. One, how big was the gain from the divestiture in the second quarter?

It was around $39 million.

$39 million. And that just gets taxed at a standard rate or --?

Yes, 38%.

So I mean we are talking about $0.15, $0.16 or something like that?

Yes, that's correct.

So we had a much weaker -- without the gain, it would have been a much weaker quarter. Now the R&D tax credit is going to be about -- (multiple speakers).

But, Eli, just to clarify, we did do better on the segment operating income line by $0.04. So I just want to get that in.

Absolutely.

Eli, one additional point here to make too, that gain of $0.16, as we talked about at the end of Q1, was offset by some write-offs that we took in Europe and that will also be offsetting that gain in our results when they are all finally tabulated. So the way that we look at it is that those write-offs related to some of our businesses in Europe have offset that gain.

And how much was the write-off in the second quarter?

About $0.16.

Well, the gain was $0.16 and how much of a writeoff did you take?

Also $0.16.

Yes, but let me just explain, Eli. The $24 million loss was applied against the $39 million gain on the other line. The rest is in the tax rate. So what Jon is saying is absolutely correct, but you don't see it all in the other category.

Okay. And the R&D tax credit, we bought something like $0.07, $0.08 and will that all be taken in the third quarter?

Yes.

So the third quarter is helped. And is it about $0.08 a share or something like that, the magnitude of the R&D tax credit?

You're close, I think, but let's follow up after the call to make sure on that.

Not a problem. And can we talk a bit about your inventory levels across the corporation? Are you happy where they are? The numbers, you can't read the numbers if you have acquisitions in them, but the corporate inventories, are you pretty satisfied where they are or do you expect to build some or have to reduce some?

Actually, through the second quarter, we didn't build inventory on our core business. Actually the inventories were down and so we were happy with the fact that we have been able to maintain discipline there through that period. And that is kind of what we are going to be doing going forward. Our message is we don't want to build inventory. We want to maintain our just-in-time methodology as far as how we are going to service the customer. And with our lean efforts that we have had going on for quite some time, that enables us to do that. So I am very pleased with actually the inventory levels. We are now right in the 10% of sales range as far as inventories and of course, years ago, that used to be closer to 20%. So doing a good job there.

So we are planning the rest of the year at keeping inventories relatively flat and so it's -- (multiple speakers).

Yes. Until we see some signs and then we will be able to respond. We have got capacity, so there is no need to build inventory at this stage.

And I guess earlier question you said if you adjust acquisitions, it was 30% or 40%. Those were the incremental -- the detrimentals that we are talking about in the quarter? 30% for North America and 40% for the rest of the world?

That's right. A little higher than 40% in International, but, yes, you are right, Eli.

I just want to make sure we are doing that. We are looking at basically being able to hold that level of profitability core business-wise for the rest of the year is the expectation at this point.

That's right.

All right. Thank you very much.

Ann Duignan, JPMorgan Securities.

Hi, guys. Good morning. Don, I want to go back to something you said at the beginning of your comments. I think you said that, across both North America and International, customers kind of put their hands in their pockets in the middle of December and ordered nothing. Can you just give us a little bit more color on that and was it distributors or was it OEM customers? Was it a bit of both or what exactly did you mean by those comments?

Well, I was just -- I don't really -- I think maybe the other people here can comment on specific segments, but I was just talking overall, the overall activity levels kind of really did slow down. I won't say it went to zero, but come about midmonth, it really trailed off pretty fast. And I think that -- and that happened in Europe, it happened here. It was kind of a universal thing. I think that all happened as a result or anticipation of this cliff fiasco. I think people are just scared to do much of anything and they didn't want to get stocks up real high. So I think we are going to see the benefit of maybe some of that coming back to a more normalized level in the third quarter and -- but that is my inclination anyway. I think everyone was just on the edge of their seat wondering what the heck was going to happen in Washington DC and so it was a little bit of a paranoia from that standpoint.

And any comment on what you are seeing out there currently from distributors versus OEMs?

Well, I would say a positive. In both areas, I think positive. And I would just maybe make a comment on a couple of the market areas that we would see as trending strong right now. Distribution would be one, still positive trends in distribution. Real strong segments for us right now would be farm and ag, process industries, oil and gas and commercial aerospace OEM. Those would be very, very strong. Just strong would be defense aerospace OEM, defense aerospace aftermarket. I mentioned distribution would be strong, residential air conditioning and commercial refrigeration. Those would be the key segments. There is about 10 that I mentioned, but again the real strong ones are farm and ag, process oil and gas and commercial aerospace OEM.

And any end markets incrementally weaker?

Yes, I can give you a few of those. Forestry, general industrial, machine tools, marine, construction, mining, commercial air conditioning. Those would be some that would be trending negative. And then kind of flat right now, I will give you those. Cars and light trucks, power gen, semicon, life sciences, heavy-duty truck, industrial refrigeration and commercial aerospace aftermarket. That is kind of the lay of the land right now.

Okay, that's great color. I appreciate it. Any of them stick out, Don, as surprising to you either on the strength or the weakness?

No, I would say not because I think these trends have been going on for a while now, so I think nothing really jumped out significantly from what was happening all along. We are just kind of tracking these going forward. So unless anybody else has any comment in that area, I wouldn't have anything else to add.

You know, Ann, you read the same things I do, but the agricultural market has obviously been very resilient and Aerospace was very strong this quarter. Not that we didn't expect Aerospace to continue to be strong, but the orders were very nice this quarter.

And were those aftermarket or OE?

Actually we received some orders for military OEM, F-15, F-18 type of thing. So maybe everybody is trying to rush ahead of any type of sequestration; we will see. But thanks, Ann, thank you very much.

Okay, thanks.

Jeff Hammond, KeyBanc Capital Markets.

Hey, good morning. A quick follow-up on Aero. So Jon, you mentioned 11% sales kind of the peak exiting the year around 9%. What would you consider to be normal and what is kind of a reasonable timeframe to get back to normal?

I think, as Don indicated, Jeff, we should be really trending back down to the 8% range. 8% range would be normal for us moving forward. And that is what we are expecting.

And what is a reasonable timeframe to --?

I think we will start to see those levels here in FY '14 and as FY '14 moves ahead and certainly by FY '15, given the OEM development cycle that we are in right now, I think that is the trend that we are going to see.

And then on acquisitions, I think you cited eight deals, I think $600 million some of acquisition spend in the first half. Can you just talk about pipeline? Do we take a pause here or do we still see quite a bit of activity?

Jeff, Don. As far as the acquisition activity, we do have other things that we are looking at. I don't think there is anything that would land in this quarter coming up. Potentially maybe something by the end of the fiscal year for us. But the one thing we are really focused on now, especially in the current environment, is we have got a little breathing room here. So the key is to really get these acquisitions digested that we have already made, these eight that we've made. There is plenty of work to do there, so while we have got a little bit of not a real aggressively high-growth timeframe that we are in is to really get those acquisitions generating positive revenues and returns for us. That will be the focus. But we are not taking our eye off of other opportunities.

Thanks, Jeff. At this time, I think we are going to move to one more question and then we are going to close with some final comments from Don.

Nathan Jones, Stifel Nicolaus.

Good morning, everyone. So Don, you had said at the beginning of this year that it was your intention to offset that $0.35 in pension cost with share repurchases. And now with the M&A pipeline a little bit quiet, should we anticipate some maybe more aggressive actions on share repurchases in the second half of the year?

That's a good question. We have done now -- we are doing $50 million a quarter in dollars that is and we did an additional $57 million in share repurchases in the first quarter. So that is about almost 2 million shares we did overall for the year. Are we going to do more? I think that will depend on what we actually see here as we look at actionable acquisitions. We certainly have the capacity maybe to do some more, but we don't want to use up all of our dry powder here on share buyback if we have got something that we can actually acquire in the next few months. So I'm not against repurchasing shares and we have done some of that and we will constantly look at that. We are also looking at the dividend again right now as well.

And if I could just get one in on China, it sounds like you guys are hinting a little bit that things are improving over there. Can you talk about what impact you are seeing from stimulus efforts over there or what it is that is giving you a little more confidence in China now than you seemed to have last quarter?

Just some of the feedback that we are getting, some anecdotal kind of feedback that we are getting from different segments, the projects that were kind of put on hold, some of the projects that were put on hold, there is some more activity going on. I am not trying to send a message that this is going vertical on us, but it is just a gradual positive movement, at least some input that we are getting indicates some positive movement there. But nothing that is going to be -- it is all in our forecast, it is all in our guidance already, but it is better than what we have heard in the last year. At least the tone is better than what we have been hearing.

All right, guys. Thank you very much.

Thank you. So at this time, Don, we will move to closing comments and prior to that, I just want to say thank you and Don?

Okay, well, thanks to everyone that is on the call. We appreciate you tuning in this morning and getting that update from us. As always, I would like to also thank all of the Parker employees, some of those, of course, would be listening in as well and the team is continuing to do an excellent job, especially through this period. A lot of activity going on with acquisitions, a lot of activity going on with new products as I indicated in my opening comments and executing the win strategy. So there are a lot of good things going forward and the team continues to excel. So I want to thank the team, the global team for all their hard work and effort.

As we go through this period, we are going to continue to manage our costs. We didn't talk a lot about what we are doing, but I think we did last quarter. This is a continuation of short work weeks where appropriate, associates and other employees have been adjusted according to the current level of activity and other adjustments that we are making in our cost base, as well as our capital allocation to make sure that we are not getting too aggressive in certain areas with our capital deployment. So we are going through that. We're looking at all of these areas and managing costs through this period.

So we want to maintain a strong financial position. Of course, we want to meet our guidance that we gave you and I went into a lot of that in the opening comments. So once again, I want to thank everybody for their participation today and if you have any additional comments or questions, Pam will be here to take those throughout the day. Okay, thank you very much. Have a good day.

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