Earnings Call: Q2 2012

Jan 20, 2012

Summary

Q2 set records for sales, net income, EPS and segment margin, with 8% organic growth. FY EPS guidance was reset to $6.90-$7.30 as international weakness and FX weighed, offset by North American strength.

Good day, ladies and gentlemen, and welcome to the second quarter fiscal year 2012 Parker-Hannifin Corporation earnings conference call. My name is Jasmine, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today's conference. If at any time during the call you require assistance, please press star followed by zero, and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, to Ms. Pamela Huggins, Vice President and Treasurer. You may proceed. Thank you very much, Jasmine. Good morning, everyone. This is Pam Huggins speaking. I would like to welcome you to Parker-Hannifin's second quarter fiscal year 2012 earnings release teleconference. Joining me today is Chairman, Chief Executive Officer, and President, Don Washkewicz, and Executive Vice President and Chief Financial Officer, Jon Marten. For those of you who wish to do so, you can follow today's presentation with the PowerPoint slides that have been presented on Parker's website at www.phstock.com. For those of you not online, the slides will remain posted on the company's investor information website at the same location one year after today's call. At this time, reference slide number 2 in the slide deck, which is a safe harbor disclosure statement addressing forward-looking statements. Again, if you haven't already done so, please take note of this statement in its entirety. Slide number 3, as you know, this is required and indicates that in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers, and again, are posted on Parker's website. To cover the agenda for today on slide number 4, the call will be in four parts. First, Don, Chairman, Chief Executive Officer, and President, will provide highlights for the quarter. Second, I will provide a review, including key performance measures of the second quarter and conclude with the fiscal 2012 guidance. The third part of the call will consist of our standard Q&A session, and the fourth part of the call today, Don will close with some final comments. At this time, I will turn it over to Don and ask that you refer to slide number 5, titled "2nd Quarter Fiscal Year 2012 Highlights. Thanks, Pam, and welcome everyone on the call. To start the call, I would just like to take a moment to point out some of the highlights for the quarter. First of all, just to make the overall comment that we have had just an outstanding quarter for the company, not only an outstanding quarter, but an outstanding first half for the company, so we are pretty excited about that. We did see some demand moderating this quarter, which is what we anticipated. We had a December meeting with the investors in New York, and we talked about that a little bit, and especially as it pertains to our international business. What is materializing is pretty much what we had seen building over the last several months. However, we're certainly pleased to announce a number of second quarter records for the company. I'll just kind of highlight a few of those for you here. We had record sales, net income, and diluted earnings per share, and those were all second quarter records for the company. Total segment operating margins were also a second quarter record at 14.2%. Keep in mind that the second quarter in our fiscal year, not just this fiscal year, but in any fiscal year, is typically our worst quarter, and we continue to remind everybody of that. This year was no different, but to come in with 14.2%, we're pretty excited about those kind of numbers, being able to post those in one of the toughest quarters that we have in our fiscal year. Again, that margin, the 14.2%, was really driven by an outstanding performance in our industrial North American operations, and they came in with 16.5% operating margins, so well above our 15% target. The other thing I would note is that virtually all of our sales growth in the quarter was organic, very little in there for acquisitions, so it was virtually all organic growth. Orders increased, as you had seen in the press release, about 3% and have moderated. Again, at the beginning of this fiscal year, we pretty much predicted this, that the first half was going to be strong and the second half was going to be kind of single-digit growth numbers, and that's pretty much what's materializing. Albeit, the mix is a little different. We didn't expect North America to be quite as strong. We didn't expect international to be as weak as it is, but we have some offset there. All in all, we're pretty much doing what we anticipated to be doing for this fiscal year. The backlog for the quarter, ending backlog, was up 4% compared with the same quarter a year ago, so we do have a build in backlog, which is a positive note. Operating cash flow remains strong at 9% of sales, and we certainly like that number. I know there'll be discussions about acquisitions. We can talk about that more. We're at pretty much various stages with regard to acquisitions on a number of acquisitions. We don't forecast acquisitions. We don't predict acquisitions because we never know when we're going to get them to the finish line. As it is right now, there is a number that we are in negotiations with, and hopefully, some of these will close before the end of the year. So that would be a positive going forward. We've acquired about $20 million in incremental sales this fiscal year so far, in addition to the buyout of a joint venture that we had in China. Yesterday, we announced an offer to buy out the remaining shares of Parker TAIYO, Ltd. of Japan, and we've been a majority shareholder there since about 2006. I'll just talk a little bit about the international segment. We obviously heard a lot about the international. If you've been reading the papers and paying attention to the news, there's a lot of well-publicized and ongoing information about how unstable the conditions are in the international segment, especially in Europe, across a number of our key end markets. We've adjusted our full-year diluted earnings per share guidance back to where we were at the beginning of the year. If you recall, when we started this fiscal year, we had a nominal $7.10 for the year guidance, and we increased that guidance after the first quarter because we actually beat the first quarter by about $0.30, I believe the number was. So we added that back to the guidance, and that's where we ended up with the higher number. We're now bringing the number back down to where we were at the beginning of the fiscal, based on what we're seeing right now. So the mix hasn't been the same, like I said earlier, but the end result is going to bring us right back into that nominal $7.10 plus or minus kind of territory. We expect current North America conditions to continue through the balance of the year, and the strength is not just coming from one market segment, it's coming from a broad range of market segments. We can talk later about PMIs and different specific segments and what we're seeing. I can give you a little color on that later. But right now, we don't anticipate anything bad happening in North America, any negatives coming out of what's happening elsewhere in the world, at least at this point in time. So right now, we expect that for fiscal 2012, earnings from continuing operations, like I said, would range somewhere between $6.90 and $7.30, and that nominal is somewhere around $7.10. That represents about a 6% adjustment from where we were previous, and still anticipates an all-time record year for the company. But we'll talk more about that after Pam gives you some more detailed review of the quarter. Thanks, Don. So at this time, I'll ask that you reference slide number 6, and I'll begin by addressing the earnings per share for the quarter. Fully diluted earnings per share for the second quarter came in at $1.56, in line with what you saw on the press release this morning. This is an increase of $0.17 or 12% versus the $1.39 from the same quarter a year ago. While the $1.56 is down sequentially from the first quarter, this is normal for Parker due to the natural cycle of the business and in line with historical performance. But to get back to the $0.17 increase in earnings per share for the second quarter, let me just outline for you the puts and takes of that $0.17. Segment operating income added $0.19. Higher expenses below segment operating income impacted EPS by $0.04. A higher tax rate impacted EPS by $0.09, and a lower share count had a favorable EPS impact of $0.11. Sales were higher in all segments of the business, with the exception of Climate & Industrial Controls Group, and all segments generated increased operating income year over year, with the exception of international. International was slightly less than last year in spite of the sovereign debt issues and slowing economy in Europe and Asia. The less-than-expected performance in international was due to less sales than anticipated on a higher expense base, continued investment in Asia, and the impact of currency, mainly the euro, as it continued to weaken throughout the quarter against the dollar. I am sure we will talk about these issues a little further as we go through the call. Expenses below segment operating income were impacted by higher corporate G&A, and that was due to higher research and development costs and performance incentives. The higher tax rate was due to a higher mix of domestic sales versus foreign. Of course, we always have this multi-period R&D tax credit that was booked in the second quarter last year. The lower share count is the result of share repurchases. Moving to slide number 8. Looking at the top line, revenues for the year increased 8.4% to $3.1 billion, and that is over $2.9 billion last year. Sales increased across all segments of the business, again, except CIC. You should note that CIC generated slightly more income on less sales. There was a minimal impact from acquisitions and currency in the quarter. As a result, the organic growth was the same as the top line, 8%. Segment operating margins for the quarter increased 20 basis points from 14% to 14.2%. Again, as Don said, an all-time second quarter record for the company. Now moving to slide number 9, focusing on the segments for just a moment, commencing with North America. North America revenues came in at 13.2% for the quarter. Acquisitions and currency had little impact. As such, the organic or core revenue increased 13% as well. Operating income increased from $159 million to $196 million, and this is a 23% increase for the quarter year over year. Operating margins for the quarter increased to 16.5% from 15.2%. Moving to slide number 10 and continuing with the industrial segment, but moving to international. Organic revenues increased 5.3% in the year. Again, currency had minimal impact on revenues. Acquisitions added 1% to revenues in the quarter, and so total revenues for the quarter increased 6.2%. Segment operating income decreased to $166 million from $168 million, and operating margins decreased to 13.6% from 14.6%. Again, due to the reasons that I cited earlier. Moving to slide number 11 and focusing on the aerospace segment. Aerospace reported revenues increased 8%. Again, acquisitions and currency had no impact to revenues. Margins increased 40 basis points for the quarter to 14.2% from 13.8% last year. This, of course, is due in large part to higher sales volume. Moving to slide number 12 and addressing the Climate & Industrial Controls segment. Revenues decreased 3% for the year. However, margins were up in spite of the decreased sales. Segment operating margins as a percent of sales were 4.7% for the quarter, versus 4.4% last year. This is obviously due to the continued restructuring efforts that we have talked about over the last several calls. And again, restructuring going on over time in that group, so you're seeing some of that in that bottom-line number. Moving to slide number 13, addressing orders for a moment. Just to remind everybody, these numbers represent a trailing 3-month average, and they're reported as a percentage increase of absolute dollars year over year, excluding acquisitions and currency, except for aerospace. Aerospace is reported using a 12-month rolling average. As you can see from this slide, orders are up 3% for the December quarter just ended. North American orders increased 8%. Industrial international orders increased 1%. Aerospace orders were flat, and Climate & Industrial Controls Group orders decreased 5% due to the continued weakness in their markets. So I'd like to move to the balance sheet just for a moment here. Parker's balance sheet, of course, remains solid. Cash on the balance sheet at year-end was over $488 million. Days sales in inventory increased to 63 days from 62 last quarter. That's pretty much typical for Parker. We tend to build a little inventory in the first half, and then we tend to reduce it even more than what we build in the first half and the second half. Accounts receivable in terms of DSO closed at 48 days, consistent with the first quarter, and weighted average days payable outstanding increased to 54 days versus 51 last year. So moving to slide 15 and addressing cash flow. Cash flow from operations for the quarter came in at $254 million, 8.2% of sales. On a year-to-date basis, $563 million, or 8.9% of sales. The major components of the uses of the quarterly cash flow of $250 million in the quarter is as follows: $76 million returned to the shareholders via share repurchase of $20 million in dividend payments of $56 million. $53 million or 1.7% of revenues utilized for CapEx purposes. However, please note that CapEx purposes on a year-to-date basis is only 1.5%. So 1.7% for the quarter, 1.5% on a year-to-date basis. In addition to these uses of cash did decrease rather another $50 million in the quarter, and that was mainly due to the effect of exchange rate changes on the cash. In total, cash increased $64 million in the quarter. Moving to slide 16. You can see that the debt-to-total cap ratio is 25.2%, and on a net basis, 19.5%. So obviously, the company has a lot of capacity to grow the business moving forward. What you've all been waiting for on slide 17 and 18, the revised guidance. On slide 17, the guidance ranges are reported for revenue and operating margin by segment. On slide 18, the guidance has been provided at the midpoint and in total for the items below segment operating margin. On slide 19, the guidance is summarized on a diluted EPS basis. As you can see from this slide, the revised guidance for the fiscal year is projected to be $6.90-$7.30. This revised guidance range incorporates the low end of the previous guidance provided last quarter. So please remember that the revised guidance excludes any acquisitions that may be made in the second half of this year. Just to summarize some of the assumptions in the guidance for you, revenues increased almost 6% at the midpoint. Operating margins are projected to be in the range of 14.8%-15.2%, a pretty narrow range. Expenses below segment operating income, including the corporate administration interest and other at the midpoint, are projected at $412 million, with a very small band of ±0.5%. The projected full-year tax rate at 29%. Just a couple of points with respect to guidance. Sales first half, second half are divided 49%, 51%. EPS first half, second half are divided 49%, 51%. Realignment costs for the year projected at $0.10, and $0.03 has already been incurred, and the remaining projected expenses will hit in the second half. Fourth quarter will be stronger than third quarter. Approximately 46% of the total EPS for the second half will be in the third quarter. The fourth quarter will have higher sales, and there are some expenses occurring in the third quarter that won't repeat in the fourth quarter, such as restructuring, legal fees, inventory expenses, as well as expenses associated with inventory reduction. At this time, I'd just like to open the session to our standard Q&A. As a reminder, please be courteous. Limit your questions to one at a time. If you need clarification, that's fine to have a follow-on, but we'd like to give everybody a chance to participate. At this time, please open the call. Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. Please press star one to begin. Your first question comes from the mind of Jamie Cook with Credit Suisse. Please proceed. Hi. Good morning. Good morning, Jamie. I guess Pam or Don, just a couple of quick questions. When we look at your order trends, you are nice enough to give us the October and November order trends when we were at your Analyst Day, and it just implies December sort of fell off a cliff. I guess what surprises me is Aero took a big hit and North America took a big hit, whereas the rest of the world, where everyone was surprised, it did not seem like it saw a material decline. I am just wondering if you can sort of explain that. Was there anything in the quarter? Is it seasonality in December? Was there less business days? If you could sort of just speak to that. My second question, can you just comment about inventory levels at Parker and the level that you will need to reduce that and inventory levels at the distribution level? Jamie, this is Jon. Hi, Jon. How are you? Good. I'm going to try to first handle the orders questions here. Let me just start out with aerospace. The aerospace orders are really as a result of very tough comps. We are at all-time record highs in terms of the backlog there. Again, aerospace being on a 12-month rolling number here, there's a lot of changes as we look at what would've been dropping off a period 12 months ago. I wouldn't read too much into that. As you mentioned in the Analyst Day discussion that we had in December, the beginning of December, we had just gotten our November numbers. You're right. As things rolled through in the month of December and for the quarter, we got progressively weaker in terms of our inventories in North America as well as in Europe. However, I think the key point for North America, our projections for North America in terms of our revenue that are built into our guidance is quite healthy. We are really relying on those projections where we're going to see a rebound in North America as the quarter goes on and into Q4. So we feel very good about our projections in North America in terms of revenue. Internationally, we've baked in the decrease that we saw in December into our revenue forecast. We're going to see really two effects. One, the ability for us to make sure that we are watching every single month the order rates that we're seeing in Europe and making sure that we are able to keep our cost structure in line. Internationally, in terms of areas other than Europe, primarily Asia, of course, for us, we expect to see an increase over time throughout the third quarter, beginning in the end of February, beginning of March timeframe in Asia, then that increase building in Asia throughout the year. So you're right. By deduction, our December was not as strong as we would've liked. There's often, when you're looking at just one period of time, some seasonality issues there. Of course, the uncertainty related to the situation in Europe we're sure affected some orders at some point here in the month of December. As we look forward and we look at the demand patterns that we're expecting from our customers, we feel like we have it really solidly built into our forecast going forward. As we looked at the data for the year, for the second half, we will still end up with mid-single digit organic growth for the company will be at about 6% for the company overall for the year. So we'll still be meeting all of our organic goals that we commit to everybody here every year which has been part of our strategy. Of course, as you know, it doesn't include anything that we'll be planning on doing in terms of acquisitions. Just the second follow-up question on the inventory levels at Parker at the distributor basis. Yeah. I think we don't have any information that would lead us to believe that the inventory levels at the distributors are any different than they have been normally at this time of the year. Although our inventory is up as a company, as Pam mentioned in her comments, the inventory goes up seasonally for us in Q2, then we always drive it down. I think we're at 63 days of inventory on hand at 12/31. We were really at 55 days of inventory on hand at June 30. We intend to be well below that 55 days by the time we get to June. That's built into our planning here for the second half. But in terms of the actual inventory on hand at our, we think that we are pretty much in the same band that we are normally in given this time of year. Jamie, this is Don. Did you want to know something more about the distribution? Well, no, I guess my follow-up question really isn't on distribution. Again, on the order trends, Jon, you cited, I think, a little bit of seasonality. That shouldn't impact us year-over-year. So I guess I don't get that. Was there something specific to this year? I think GE this morning said there were less business days or something. Did any of that impact you or? No, I think I'm just trying to get It just doesn't make sense. Well, the thing that for us in the month of December, again, we shared the October and the November data with you in the meeting at the beginning of December. In the month of December, we saw a worsening of the order rates year-over-year. When I mentioned seasonality, all I was doing is trying to compare what's happening in Q2 versus Q1 and just trying Okay to think that our normal rates are going down. I understand year-over-year that we're in the same impact. However, I do think it's fair to say in terms of Europe and what's happening in Europe, that there is some uncertainty. In some pockets of our organization in Europe, we saw some order rates that we wouldn't normally see in the month of December in Europe. But our look at Europe going forward is baked into our guidance, and we feel very good about being able to make our organic growth rates as projected in our revenue forecast that Pam just described earlier. Jamie, this is Don. Just to add a couple of points to that. First of all, the strongest segment for Parker right now is our distributor business. Okay. It's absolutely the strongest of all of our segments, OEM or otherwise. I don't anticipate our distribution cutting inventory or adjusting down inventory. If anything, they might even be adding some inventory to deal with their business conditions, because that's really the driver right now in the company. It's the aftermarket in particular. It's the strongest segment for us. The other thing to keep in mind is December is always a lousy month. I like December, don't get me wrong, because I like the holidays and all that. But from a business standpoint, it's a lousy month. With the holidays and all that, and every December is, we don't have a good December typically ever. Really, when you look back through the years, it's a light month. You can't read a whole lot into it. I think more importantly, to stay focused on our backlog. In the second quarter compared to last year, the second quarter, our backlog increased 4%. That's kind of an indicator going forward as to what's to come. Okay? So we're building some backlog from year to year, quarter to quarter. I think that's probably more important than try to read too much into one month of December. Okay. I appreciate it. I'll let someone get back in queue. Thank you. Your next question comes from the line of Jeff Hammond with KeyBanc. Please proceed. Hi, good morning. Good morning, Jeff. If we take the guidance revision of $0.45, is there a way to bucket that between European weakness, FX translation, anything else? And maybe within the international business, if you can just kind of correlate the organic growth with the margin decline. Is that price cost? Is that mix? Is that inventory absorption? Yeah, I think, Jeff, Jon here again. In terms of the guidance, the whole story is really when you look at the numbers going forward, as we've broken it down by segment, is in our international business. It is both in terms of revenue as well as in terms of margins. We've also got a little bit in there for, we've raised the tax rate up to 29% from 28%, and that's the way that we're really looking at the guidance for us and the change in the guidance. That is the whole picture. If you really looked at our prior guidance versus our current guidance, we're at a $0.37 impact there. So that just about covers that entire $0.45 that you're talking about. That gets to the point that Jamie was making earlier that we try to talk about in terms of our view of the international growth rates. As we tried to talk about in December, we were worried, and we said that we were worried in December about the trends that were developing internationally for us, especially in Europe. But we were also very mindful of the strength that we were seeing in North America. We really wanted to be able to tell you exactly what was going to happen at the end of the quarter. We didn't know, of course. We were only through two months, and we had just gotten the fresh November data. But once we finish the quarter and we go back and we look at it, we almost cover in North America. North America's increasing in our guidance as the year goes on, and it's just not able to give us the confidence that we're going to be able to cover what we're seeing internationally, both in Asia, but of course, primarily in Europe. That's probably the picture in a nutshell for you. But it's all international. It's not anything else other than that. We're going to be keeping a really strong focus on that. As Pam mentioned, she talked in detail about the difference between the expenses that we have got baked into the guidance for Q3 versus Q4. In fact, we've got about $20 million in additional expenses, mostly restructuring related to what's happening in Europe into Q3. We'll also have some legal and other types of costs that we've got baked into Q3 guidance too here. We see the issues, we see the influences on us. It's consistent, as Don said, with the macroeconomic picture. We're taking action. We're taking action based on what we're seeing and how those markets are trending in order to be sure that we come in with the guidance that we've provided you here today. We feel very good about our visibility into Q3, and we're very confident in the guidance that we've just given you. Okay. Is there a way to quantify the FX translation impact, either on the EPS guidance change or on this five-point swing in international revenue growth at the midpoint? Well, I think that in terms of the top line, about half of the top-line delta between our old guidance and our current guidance is FX related. That will have a material impact on the bottom line for us, and we can get into a lot more details with you as the day wears on here, if you would like. Okay, thanks. Thanks, Jeff. Your next question comes from the line of Joel Tiss with Buckingham Research. Please proceed. Wow, I made it before the end. How's it going? Good morning, Joel. I just wanted to follow up on the direction that Jamie was going into, and I don't know if you guys want to answer this, but I think it would be very helpful for everyone on the call if you could give us a little bit of a sense, if you were a calendar year, what 2012, sort of the order growth rates and pricing trends and some more color on different regional trends with what you're seeing. Because there's a lot of different parts of Europe. You haven't talked about Latin America at all, and I just wondered if you could give us more of a snapshot of how you're seeing calendar 2012 and what the January order rates look like and what you're hearing from your customers, more on that kind of a view. Well, Joel, I'm not sure where we want to start on that, but I can maybe start with a little bit of what you may already know. Maybe not everybody on the call knows about the PMIs and what they're looking like globally. But right now, what we're looking at is on a global basis, PMI is around 50, which is kind of neutral territory for the overall market globally, but not a bad number. North America, I think bodes well, being as pretty much in line with what we've been saying here is that the PMI increased to almost 54 from about 50, just under 53 in November. So actually, the activity in North America, that was for North America, I don't know if I mentioned that. So for North America, we kind of see that going into the new year as a real good sign. The Eurozone, it actually went up just a little bit from low 46 to higher 46, but nothing really to write home about. All of the Western countries in Europe, for the most part, are below 50. So that just kind of confirms the weakness that we're seeing here. China is around 49%, just a little bit less than that. It was closer to 50% in September, so down a little bit. We anticipated, by the way, with our guidance at the beginning of the year that our first half was going to be strong and our second half was going to be weak. So none of this really surprises us. It's just maybe some of the pieces moved a little bit here or there, but I think what we're seeing develop is pretty much exactly the picture that we saw going in, and we said that our growth would be kind of single digit in the second half, and that's kind of the way it's materializing. You mentioned Brazil. Actually, their PMI, they've been kind of flat lined for quite a while, but they've actually increased a little bit on the PMI now to around 49 from 45 the previous quarter. So that's kind of moving up. You saw our order trends are up about 3%, and I think most importantly, again, is the backlog that we're running about up 4% quarter-over-quarter. I think that's kind of an indicator of what's to come going forward. I could go into the order trends by region, but I think I'm just going to be repeating myself. I've got 3/12s and 12/12s. I would say the strongest trend for us anywhere in the world is our North American distribution. Okay? It's the strongest trend, both on a 3/12 and a 12/12 that I see anywhere in all of the regions and segments that we deal in. What else? I think that's probably. I mean, I can go into some specific segments and so forth. Like semiconductors flattening. Refrigeration, of course, we talked about that with CIC, and air conditioning is weak. Housing builds, of course, are dictating that. Construction, on a 12/12 basis, is pretty strong. The 3/12 is coming down a little bit, but that's to be expected. Those would be just some inputs. I hope I answered a little bit of what you were looking for. Yeah. On aerospace, can you give us a sense of why the growth? It looks like if you, I know you don't report it this way, but if you just took the fourth calendar quarter of 2011, looks like the growth really fell off a lot. You said it was tough comps. Is there anything in commercial aftermarket that would have amplified that? Yeah, I would think that the commercial aftermarket, Joel, is still very strong and very good. The impact that we're seeing that are the headwinds in the aerospace orders going forward is, of course, the defense business. This would be defense OEM as well as the defense aftermarket. The commercial side of the business is still very good and we're expecting the guidance that we gave there to continue strong. We are still, as we talked about in the Analyst Day presentations that we made, referencing an 8% compounded annual growth rate for the next several years in aerospace, based upon all of the wins that we've been able to make over the last year. So you might see some changes in the backlog, but those were all anticipated, and that's really more related to the defense than the commercial side of the business. Okay. Thank you very much. Joel, I'll just add one other thing I wanted to just cover. Just some specific market segments that I can just give you a little color on. North America, strong segment, doing better. Mining, oil and gas, power gen. I mentioned distribution being extremely good for us. So those would be some other segments that are looking good. Worse would be semiconductor and heavy truck, although heavy truck's running at a fairly high level, so don't read too much into that. Internationally, this would be primarily Europe now that I'd be talking about. The mobile markets are soft. Cars, light trucks, soft. Construction, heavy-duty truck, those are all soft, and farm and ag. You can see pretty much across the board, those segments in Europe are soft. On the positive side, power gen, semiconductors is more positive now than it has been, but it's a small change. Marine is strong, oil and gas is strong. So you can see the power and energy markets are doing pretty well, even in that environment internationally. And that specifically was speaking to Europe. China would follow that pretty much exactly along the same lines as I just mentioned for Europe, with the exception that cars and light trucks are still good in China. So the rest of the segment's pretty much parallel with what I just said. Hopefully that adds a little color, too. Yeah, thank you. Sorry for taking so much time. No problem. Your next question comes from the line of David Raso with ISI Group. Please proceed. Hi. Good morning. Good morning, David. First, a clarification. At the Analyst Day, you were providing rolling 3-month orders, right? So it wasn't that North America was up 18% in October and 13% in November standalone, then you back into a down December. Those were rolling 3-month numbers you were providing for October and November, correct? That is correct, David. Yes. Okay. Thank you. My question relates to, I think it was Jon who made the comment that organic growth for the company in the back half could be, I think you said 6%? What I meant there, David, is 6% for the year. Okay for the company. Right. We're going to be in the 1%-3% range. 3% is the implied guidance for organic growth for the second half of the year. Okay. Because I'm trying to back into the currency impact you're baking into international and what that's implying for organic international for the back half. Because the full-in number is back half, you're saying international revenue is down 4.7%, but margin's only down 10 bips year-over-year in the back half. So how much is currency in the second half for international? Is it 5%? I'm just trying to think, are we implying organic growth internationally is flattish in the back half? You're about there, David. Okay. I apologize for repeating my question from last quarter, but unfortunately it kind of happened again with the international margins. If we were down 60 bips in international margins in the first quarter, now 100, and you would think that maybe the outlook's weakening here a little bit, at least in the next coming quarter, to have margins only down 10 bips year-over-year in the second half is, again, just a question from last quarter. Why would the margins be only down 10 if we're not growing the business at all and costs have gone up in Asia, and maybe even the currency's a bit of a drag on the profitability? I think that's a debatable point, but can you explain why the margin's only down 10 bips in the second half internationally? I have a little more than that, so I don't know where we have a disconnect on our numbers, but there's a little bit of disconnect on the numbers, David. Yeah. Well, back half of 2011, 15% international margins. Second half implied 14.9. Maybe you're off by 10 bips or so from my number. Right. Yeah. Okay. I'm just saying inherently a business like this- I see where you're coming from, yeah. Flat organic growth at best doesn't usually implied margins flat or down slightly. You should take a bit of a hit. Is there something with, actually the currency going away, your currency is less of a drag on profitability, but you don't get the same margin on a currency dollar. Right. Yeah, I'm just trying to. You would think it'd be a little more. Well, part of it is because of the European margins. You have to remember that our European margins are lower. Yeah than the margins in the rest of our business. The currency does have a much smaller impact to the profitability than what maybe you might see on the sales line. That is my last question. The international, obviously, I was thinking about Europe. I am a little more concerned about the margins in the emerging markets. Would that be more of an unpleasant surprise to folks? They at least feel they can somewhat calibrate Europe, potentially. The emerging market margins, how are those trending right now? All in with the investments as well, but even just if you can think of it with investments, without the investments, international margins, how are they trending right now? That is a good question, David. I think that, David, this gets to the point that you were asking about earlier. As our international business changes over time, of course, we are growing bigger in our emerging markets than we are in Europe. As the margins are changing at a different rate in Europe vis-a-vis what is happening in Asia, as an example. However, as we have talked about before, our margins in Asia are very good, but they are slightly down from where they were. That is having an impact on us. They are slightly down because we are putting in a, as we have talked about before, an infrastructure there in some of our CapEx program, and we are creating opportunities for us to really invest in growth for the future. And so it just so happens that as these facilities are coming online in Asia, they are having a very minor but noticeable impact to us, in terms of the margins internationally. Again, we're very proud of our emerging market margins, but your point is well taken, and your analysis of the situation is accurate. And that triggered a question for me. You made the comment about EMs maybe getting better. I think you said Asia, to be specific. Is there anything in the order book to suggest a pickup? Because, again, I'm just not hearing that post-Chinese New Year pop that we usually get. So the CapEx goods post-Chinese New Year seems, at the moment, going to be a little disappointing. Are you hearing something differently, or are you looking even beyond that March, April timeframe, and there's something in your order book suggesting that pickup in April, May? Because I'm just- Well, I think in China, it's been down for quite a while now. I think that just from what we've been hearing as far as the banks and the access to capital and so forth is being softened or released a little bit, lessened, more available, however you want to put it. I think that's going to bode well. The only question that we have is what month or months is that going to really happen? Our people in Asia say that it's going to happen this second half. We can't pinpoint. We were hoping that it would start in January. It looks like it may be pushed out a little bit, but I'm hopeful that still we start seeing a little bit of a pickup in the third quarter sometime. So it's a macro thought, not a micro in the order book thought. Yeah. Exactly. Okay. I appreciate the color. Thank you very much. Thanks, David. Bye-bye. Your next question comes from the line of Robert McCarthy with Robert W. Baird. Please proceed. Good morning, everybody. Good morning. Before I ask a question, Jon, can I just ask you to clarify something you said before? The $20 million of excess expenses in the third quarter is a combination of restructuring and other things, or was it $20 million for restructuring alone? It is primarily restructuring. But we also have some incremental legal expenses that we'll be incurring in Q3 related to some of the projects that we're working on. So, three-quarters of it certainly is restructuring. I just want to clarify, Rob, because I do not want you to think that the It is a combination of things. The third quarter, what is happening is we are having some expenses that will not repeat. Then in the fourth quarter, we have some pickups of some inventory adjustments and things like that. So it is not like we have everything is in the third quarter, and it is going to reverse in the fourth quarter. It is a combination of things that are happening in the third quarter versus fourth quarter, and that is the change. Okay. Thanks. It is $21 million in total, though. Twenty-one. Okay. My first question was, I would like to try to distill down all that we have heard about the international outlook into an order expectation. I think I hear you saying that you believe that recovering order rates in Asia, perhaps Latin America, will enable overall international orders in the second quarter to be up. In other words, fully offset what you think is going to happen in Europe and allow orders to be up. Am I getting the message correctly? Yes. The second half, we are expecting orders in our emerging markets to increase sequentially as the third quarter rolls out and into the fourth quarter. Yeah, I apologize, Jon. I should have said, I meant to say fourth quarter, of course. Okay. That's how we are looking at our guidance, and that's what we're expecting, and that, again, is a result of our analysis of our forecast that we're getting from each one of our business units and the geographies and the territories that they are looking at and very close to their customers. So this is not just a macro look at the world and trying to apply it to our numbers. This is a combination of that, plus the roll-up of all the data for all the divisions around the world. That is exactly what we're expecting. Okay. Got it. My follow-up has to do with your expectations for aerospace profitability. Obviously, we understand some of the puts and takes. I am surprised to see you forecasting that second half margins would decline from the first half despite an increase in the second half in terms of revenue. My impression has been that we have some easing of the engineering expense issue. So are we looking at the impact of an adverse mix shift created by more commercial, less military? Yes. You have it very well put. We still have the engineering expenses continuing in the second half, slightly less rate than the first half. It is still in the 9%-10% range of revenues for the year. You are absolutely correct. It is the mix between the commercial and military, but it is also the mix in terms of the OEM build cycle. As the OEM build cycle continues to gain momentum, of course, that is causing a mix issue for us. We are putting our guidance together with that in mind. Our commercial aftermarket is at a very nice level right now for us. But we expect that to be flattening out as the year goes on, not giving us the momentum that we have had over time. As the OEM commercial business comes online, that will create that mix issue, which will maybe 100 basis point difference in the returns at the operating margin there. Okay. Thank you, Jon. It is very helpful. Your next question comes from the line of Alex Blanton with Clear Harbor Asset Management. You may proceed. Hello. Morning. Can you hear me? Yeah, we can hear you. Oh, okay. Hi, Alex. How are you doing? All right. My question, Pam, relates to something you said during the opening remarks with regard to the second half. You were talking about 49% of EPS in the first half and 51% in the second. So that would give you about $3.63 in the second half. Then you said 40% of that second half would be in the third quarter, and 60% in the fourth quarter. Is that correct? Yeah, I think my exact numbers were 46% in the third. Oh, well, you said 40%. Because if you use 40%, that would give you $1.45, and that looked a little bit light. Yeah, no, it's 46%. for the third quarter 46% in the third. 46 and 54. Yeah. Okay. Thank you for clarifying that because I was getting a little concerned. That would give you $1.67 in the third quarter, which then you said would be burdened by about $0.12, including restructuring and legal costs. Correct? Okay. The other question is the decline in the margins, in the quarter in international. I apologize if this has been covered before, but it was on higher sales. Why is that? There was no incremental margin. Well, I think what has happened is that our anticipation for the business was higher than what exactly happened. And when you have a fixed infrastructure, Alex, it is hard to adjust real time to the moment to any change in activity. So you are going to see some aberrations there early on in a situation like this. We will be making adjustments, and those will happen real time, but there is a little delay factor to get adjusted to what the current levels are. We anticipated a higher level of activity than what actually happened for the amount of infrastructure we had in place and- I see. the staffing and all that. I see. Those adjustments will happen. It will just be a little delay. Okay. Your sales were lower than expected, so your expenses were too high a percent. Some of the fixed expenses were just that, they were fixed. Yeah. Are you going to reduce them in the second half? Sure. We are reducing everything real time as we speak. As you know, certain regions of the world are easier to do that. Other regions are a little bit more difficult because you have to get the Vatican to approve it and whatever as far as cutbacks and I am just pulling your leg there a little bit. You have to get the works councils and the governments to approve things and so forth. Yeah, that is a little hard over there. Yeah. But we're doing that. We're making the adjustments as needed. I will say this, that, in Europe in particular, we have about, right now, about 1,000 associate employees. We prepared for this. At the last recession, we were preparing for the next recession, because one of the parts of our game plan is to make sure that we do have associate employees that we can act on a little bit quicker than we would otherwise be able to do with full-time tenured employees. So we have about 1,000. We have a couple thousand in the company total. We have about 1,000 of those in Europe, and that was down to zero in the recession. So you can see the flex that we have there. It's about a 5% of our workforce flex that we have with temporaries and associates to be able to manage through these kind of downturns. So you're not going to get much of a delay. You'll have a little bit of delay. There is still some restructuring, I think Pam mentioned that, going on over there. That's an ongoing thing. It's not a huge number, but it is happening, and it'll continue to happen until we right-size everything to the level of activity. Just along the same lines then, CapEx may be a question in your mind. What's happening with CapEx? Well, keep in mind that in a lean environment, lean drives discipline in CapEx, okay? I don't have to take any drastic measures on CapEx when the economy goes up or down. It happens automatically. When you really have a lean environment, you're monitoring that almost daily. So we're running right now at about a 1.5% of CapEx. That's at a pretty low level already, and it's pretty reflective of where I would expect to be with this kind of economic environment that we're facing. So those are some of the things that we're doing to address what's happening over, especially in Europe and international. I can give you a few more, but I think that kind of hits the highlights. Yeah. Thanks, Don. Sure. Your next question comes from the line of Terry Darling with Goldman Sachs. You may proceed. Thanks. A couple more clarifications here. John, I think at the Analyst Day, you did give the indication that November orders, industrial, international, single month November was just very slightly positive. Can you help us with December? I think the implication, you went just slightly negative in December. If that's correct, is it Europe got a little worse and Asia was still about as negative as it was in November, or can you help us with any of that? No, your logic is correct. Okay. It did get worse in December. It did go negative a little bit. It's about equal by region. Equally negative. Equally negative. -or equally deteriorated versus November? Equally deteriorated vis-a-vis November in both Europe as well as in Asia. Okay, helpful. In terms of the question on second half international margins, kind of essentially the same for the second half despite the lower revenue. I wonder if you see an expanding price raw material gap. Maybe you can talk about where that is now and where you see that heading moving forward. This is Don, Terry. We've had raw materials right now, maybe I'll just kind of highlight some of the movements there. We've had some changes. I think everybody's seen that on crude oil and so forth. Copper's been moving a little bit up, and steel, likewise. We also had some going the opposite direction, aluminum and nickel. The key for us is, and this is pretty consistent the way we've been managing this over the last five or six years now, since we've really launched the PPI, purchase price index philosophy here and the selling price index, is that what our goal is neutrality, okay? We want to achieve at least neutrality. So when we absorb, have to take raw material increases, we're not trying to make a profit on those increases other than the normal gross margin on those increases, okay? What we're trying to do is achieve neutrality. We're trying to keep the purchase price index less than one and the selling price index greater than one. We're pretty much doing that. We've done that in very difficult times. We're doing that in today, which is not as difficult environment as what we've seen in the past. We've had to manage through some very tough times when raw materials were going almost vertical. So right now, I feel very comfortable being able to manage raw material inputs and recovering those. I think we've mentioned in the past, we've had price increases across the board on all of our products at least once or twice a year, either in January or July. That holds true for this year as well. Any adjustments that will be made will be made pretty much at those times or at the contract anniversaries for OEM accounts. So I feel pretty good. We've got things under control, and that's a global statement pretty much around the world because we have visibility of these indices pretty much everywhere that we operate around the world. So flat for the year, but is the spread changing in the second half relative to the first half? The spread of what? Price versus cost. No, I would say that it is pretty much constant. Okay. Then lastly, on capital allocation, Don, you mentioned at the Analyst Day that you'd stop buyback because you were anticipating acquisitions. I was very encouraged to see the one you announced the other day. I'm wondering if you could true us up. Is that all that is in the near-term pipeline? Do you move back to buyback near term, or are you still optimistic about the deal pipeline and that's where the focus is? Well, I think what we want to do is, we do have a number of properties that we're looking at right now, candidates that we're looking at. We're at various stages of discussions with them, and I think right now our focus is going to be to try to bring some of those in. Some of these have been ongoing for some time now, and like I said, it's hard to predict when we can finally sign off on these. So I think right now, yes, we'd like to do some more deals. We have some in the pipeline. We think we've got some more to the finish line here in the near term. On the capital allocation or the cash allocation aside from that, when you're talking about share repurchases and so forth, let me just touch on the dividends first. We want to maintain a yield on the dividend, at least where we've been tracking here, if not better, over time. And gradually, we want to bring the yield up to the median of our peers. Now, our peer group is a different peer group than many on the call use for peers, so be careful with that. But I want to bring it up to the median of our peer group, and we'll do that over time. So we want to keep that track record that we have going now for about 55 years of increasing dividends every year. So in order to do that, though, we need to increase our dividend at least at the same rate as we're increasing net income, or greater, to actually gain on that yield. So I hope that's clear to you. So we're going to do that. I think the board is pretty much in agreement with that. We'll do it over time, but we'll gradually increase that yield up to the median of our peer group over time, and we will have an annual increase in the dividend every year as long as I'm around. So I can guarantee you that. The CapEx we already touched on. The pensions were in good shape. We trued that up last year. We're in very good shape. We don't have to do anything on the pension this year. I like share repurchase, especially when our shares have been depressed like they have been. We looked at our value of this company. I look at, I'm doing acquisitions, I can tell you that my best acquisition has been Parker stock at the prices we've been buying the stock at. So I would like to do more. We will evaluate that in line with the activities that we get to the finish line with respect to acquisitions. If we have additional capital and we are able to execute on what I said on the dividends, I will definitely do more share repurchase, especially at these kind of levels. We are doing about $80 million anyway a year in share repurchase just to cover stock option exercises and that. But I would love to do more. That will depend on what we get to the finish line here on the deals, and we will keep you posted on that. Hopefully, that maybe sheds a little light on our game plan. That covers it. Thanks much. Thanks, Terry. We are running out of time here, so we will take one more question. Your last question comes from the mind of Ann Duignan with JP Morgan. Please proceed. Hi, guys. How are you? Good. How are you, Ann? Okay. Maybe, Don, you would just touch on what you are seeing in North America from an OEM order perspective. You have got a pretty broad group of OEM customers. I am just interested if you are hearing anything about slowdown in orders on the back of the expiration of accelerated depreciation in any of your key end markets. I am really not hearing that in any of the markets that we serve. I think, again, the energy markets have been extremely strong for us here, if you look at really what is doing very well in North America, and I think that is going to continue on. The mining, oil and gas, power gen, and you name it, right on down the line there, those have been extremely strong. This whole distribution part of our business, of course, is the aftermarket, as I mentioned earlier, has been extremely strong. So no, I have not heard anything. There was a little bit of softening we noticed in the heavy truck, but again, you know that that has been running at such high levels. I am not really all that concerned about that long term either. I think that is going to remain a very strong market segment for us. I'm not really getting any feedback from anywhere that there's any dark clouds on the horizon. Okay. I'll leave it at that. I think most of the other questions have been answered. I'll take it offline. Thanks. Thank you, Ann. Okay. At this time, I'll turn it over to Don for just a few closing comments. Before that, I'd just like to thank all of you for your participation and look forward to talking to you this afternoon. Thanks, Pam. I just want to then, once again, thank everyone that's on the call for joining us this morning. I think we had a real good call, meaningful. Hopefully, we shared a lot of information that was meaningful to you. I'd like to also take the opportunity to thank all of our employees. I know we have quite a few employees tuning in around the world, and I want to thank them for their commitment to serve our customers, ongoing service of the customers, which they're doing a great job of. Also for their continuing delivery of the strong financial performance that we're witnessing here with these record quarters, a string of record quarters that we've had and anticipate we'll continue to have going forward. Just really congratulations to our global team for all their hard work and effort. Just one last thing for those on the call. Keep in mind that even with some of the headwinds we're facing, we've got some tailwinds as well, and we still are on track to achieve record performance in fiscal 2012, and should finish up as one of our better years for the company. Once again, I want to thank everybody for their participation and their continued interest in Parker, and I will say that Pam will be available the balance of the day to take any calls and answer any additional questions that you may have. Thanks, and have a great day. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.