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Executives

Pamela Huggins - Vice President and Treasurer

Don Washkewicz - Chairman, Chief Executive Officer and President

Jon Marten - Executive Vice President and Chief Financial Officer

Analysts

Jamie Cook - Credit Suisse

Josh Pokrzywinski - MKM Partners

Alex Blanton - Clear Harbor Asset Management

Mig Dobre - Robert W. Baird

Andy Casey - Wells Fargo Securities

Eli Lustgarten - Longbow Securities

Ann Duignan - JPMorgan Securities

Jeff Hammond - KeyBanc Capital Markets

Nathan Jones - Stifel Nicolaus

Parker Hannifin Corporation (PH) F2Q 2013 Earnings Conference Call January 18, 2013 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Parker Hannifin Corp 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 and Treasurer. Please proceed.

Pamela Huggins

Thank you, Stephanie. Good morning, everyone. This is Pam Huggins speaking just as Stephanie said. I’d 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 and Chief Financial Officer, Jon Marten.

For those of you who wish to do so, you may follow today’s presentation with the PowerPoint slides that have been presented on Parker’s website at www.phstock.com. For those of you not 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 two 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 four, the call will be in four parts. First, Don Washkewicz, Chairman, Chief Executive Officer and President will provide highlights for the quarter. Second, I’ll 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’ll turn it over to Don and ask that you refer to slide number five titled second quarter fiscal year ‘13 highlights.

Don Washkewicz

Thanks, Pam and I just like to extend the Happy New Year to everybody on the call. We certainly appreciate your participation today. Just to make a couple of comments and then we’ll 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’s 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, 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 were losing some of the higher margin business, because that business was down. And we are picking up acquisition business, which was going through integration phase that our 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 and pretty much all regions. December, in particular, was weak from mid month on as number of customers we noted, and this is true both in North America and rest of the world, held back on purchases and shipments. So about mid month, 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 the guidance that we provided the 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 the 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 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’ll 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 there we are doing in adjusting our cost base so forth in line with our go forward forecast.

I thought it would be good maybe just review some of the interesting, exciting long-term initiatives that we have that’s going to continue to help us grow and drive 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’ll 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, so it’s 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 and 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 will just remind everybody we talked about this in the past that we 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 future GE Engine platforms. And I think we are pretty excited about this joint venture. It’s going to result in some really neat state-of-the-art products and nozzle technology for the future and that’s going to bode well for us going forward, it’s 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’s been a long time in development, but it’s 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’s pretty exciting. We’ve got activity going on elsewhere initial activity and dialogue going on trying to get additional interest in this technology. So, it’s just a matter of time, this is going to continue to grow for us going forward.

Also we had 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’s currently called exoskeleton. It’s going to be renamed here as we go toward a product launch. But it enables the paraplegics to get up and walk and which is something they haven’t been to do which is pretty exciting. 2014 launch date is planed for that product and that will be the first launch and what we call a 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, comparing to last year we do have an additional pension expense in these numbers of about $0.35 per diluted share.

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

Pamela Huggins

Thanks, Don. So, at this time, if you will reference slide number six, I will begin by addressing earnings per share for the quarter. You can see that 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 are 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 than 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 eight 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 planned to incur $0.07 to $0.10 in the remainder of the year.

So, let’s move to slide nine 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 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 continue 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 margins 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 and organic revenues increased 7% in the quarter, and acquisitions and currency had minimal impact. Margins decreased 430 basis points, and this includes the higher non-recurring 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 will see on this slide, it indicates that core revenues were down 19%, but that’s 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 in currency, except for Aerospace. And Aerospace excludes acquisitions in currency as well, but it’s 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 day sales in inventory was 66 days. This is up versus last year of 63, but do remember that this includes the 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, the 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 dividends.

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

So, now I 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 the 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 cost as a result of the lower discount rate. We are projecting a tax rate of 28% for the year, and that’s 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 from $6.45 – to $6.45, but it details the changes that have occurred in the quarter. And what you can easily determine this 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’s really the result on the gain on sale of the CIC business that we divested. And then tax adds $0.04 and that’s the result of the passage of legislation regarding the U.S. research credit. We also have less shares outstanding because of our share repurchases. And please remember that the forecast excludes any further acquisition through 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 margins of 14%, and then again below the line items of $466 million with a band of plus or minus 2.4%, a 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 were 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% in second half. And then the EPS will be lower in the third quarter versus fourth quarter with a split between third and fourth quarter of 45%, 55%.

So, at this time, I think we’ll commence with the Q&A and thank you for listening.

Question-and-Answer Session

Operator

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

Jamie Cook - Credit Suisse

Hi, good morning.

Pamela Huggins

Good morning Jamie.

Jamie Cook - Credit Suisse

Hi. 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 forecast 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.

Pamela Huggins

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.

Jamie Cook - Credit Suisse

Okay.

Pamela Huggins

And then you are exactly right, Jamie to your point, we did take segment operating income down in the North America and international. Jon, if you want to?

Jon Marten

Yeah. 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’s a tough pricing environment out there. And it’s 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’ll be looking for 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. I am sorry, go ahead.

Jamie Cook - Credit Suisse

No, go ahead, go ahead, I’ll let you finish.

Jon Marten

No. 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’s I think in a summary the way that we are looking at margins going forward here for the second half.

Jamie Cook - Credit Suisse

And I am 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?

Pamela Huggins

I can do that for you Jamie.

Jamie Cook - Credit Suisse

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?

Pamela Huggins

Yeah, but let me give you some – a couple marginal return on sales numbers without the acquisitions I think might help.

Jamie Cook - Credit Suisse

Okay.

Pamela Huggins

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.

Jamie Cook - Credit Suisse

Okay.

Pamela Huggins

International, the same thing, if you exclude acquisitions not quite as good as North America, but it’s in the 40% range, so...

Jamie Cook - Credit Suisse

Okay.

Pamela Huggins

So, we are very cognizant of that. And it’s 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.

Jamie Cook - Credit Suisse

Okay, but and Pam just to clarify, so the margin improvement back half versus first half, it’s all volume, and what acquisition?

Pamela Huggins

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.

Jamie Cook - Credit Suisse

Okay, alright great. I will get back in queue.

Operator

Your next question comes from the line of Josh Pokrzywinski with MKM Partners. Please proceed.

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?

Jon Marten

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

Josh Pokrzywinski - MKM Partners

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

Jon Marten

No.

Pamela Huggins

Well, last time we said $0.05 to $0.10, but weren’t thinking that it was going to get to the upper end of that. And now we think that it is.

Josh Pokrzywinski - MKM Partners

Okay, so maybe a fair way to look at the $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?

Jon Marten

Yeah, I think that’s fair, I think that’s a fair analysis, that’s not bad at all.

Josh Pokrzywinski - MKM Partners

Okay and just thinking about cadence through the quarter, obviously October was pretty bad form 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 have gotten maybe even close to flat by the exit rate?

Pamela Huggins

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’s really difficult to get any read from orders by looking at the December, but what I will 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.

Europe we actually saw some sequential improvements 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?

Josh Pokrzywinski - MKM Partners

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?

Pamela Huggins

I think that’s a good read.

Josh Pokrzywinski - MKM Partners

Okay, appreciate it. Thanks guys.

Pamela Huggins

Yeah, thank you.

Operator

Your next question comes from the line of Alex Blanton with Clear Harbor Asset Management. Please proceed.

Alex Blanton - Clear Harbor Asset Management

Good morning. I’d like to – I got two questions. The first one is I’d like your opinion on the thought that now that uncertainties are 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’ve 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?

Don Washkewicz

Alex, this is Don. Good question and I wish I had a good answer for you, be honest with you. When we look at our business if you just kind of look regionally and then we kind of look at our order trends, because that would give us the best indication of what’s going on our 3/12 and 12/12 activity levels. And if you look in North America, we see a slightly improving 3/12, but our 12/12 curve is heading toward a 100%, which would indicate very moderate slow growth continuing at this point. So, not at a catastrophe on the horizon, but nothing hugely different from what we have seen here in the last quarter or two, so that’s kind of the way I would read North America right now. And maybe it’s still a little bit early to really see the impact of what happened with the fiscal cliff fiasco and all that. So, maybe that’s 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 little bit of an improvement there, that’s the last three months orders over the previous year three, but it’s just kind of approaching a 100% and but the 12/12 curve has been under a 100%, in other words, the orders are tracking under the prior year 12/12 month period and that continues. So, I mean 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’re basically taking actions there, restructuring things and trying to get our cost in line to basically deal with this for the long-term, but 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’s going to be more 7%, 8% growth instead of 12%. So, our 12/12 dropped, it’s negative year-over-year, but that’s because I think and as you’ve been reading about this, there is so much happening that the region is settling down and there is some maybe more realistic and normalized growth rates. So, that’s not necessarily bad.

And I think that we have gotten some near-term indications that there is a little bit of pickup 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’ll see a little bit change there.

If you ask me what would make the future better what do I think might be happening out there that might be improving, I think the – we’ve been hearing a little bit about housing starts starting to turn up. I think that’s a positive, a little bit of positive indication at commercial construction, for instance, starting to see some improvements as well as heavy duty trucks. I think there will be a little bit of a rebound there that’s been trending negative there for sometime. 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’s 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. And then, 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’s the largest at any point in time that we have ever had in the past. So that, I don’t want some negative here, I am looking at the near-term things going on, but I think if you look out a few months, I think you can see there is some maybe some light at the end of the tunnel with some of these other areas showing signs of improvement.

Alex Blanton - Clear Harbor Asset Management

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?

Pamela Huggins

That’s correct, Alex.

Alex Blanton - Clear Harbor Asset Management

So, mathematically using the midpoint of your range $6.45, that says that the third quarter would be $1.66 and the fourth quarter $2.02 to get that split, that’s a big increase quarter-over-quarter, what’s the reason for it?

Pamela Huggins

Yeah, I think Alex, you are right, I have a couple of pennies different than what you have but you are right on, I see you are doing your homework there, so good for you. You know 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 improvements, in international, I think if you look at each region, yeah we do have some sequential improvement, but it’s 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’ll be able to get that type of increase.

Alex Blanton - Clear Harbor Asset Management

Okay, thanks.

Operator

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

Mig Dobre - Robert W. Baird

Good morning.

Pamela Huggins

Good morning.

Mig Dobre - Robert W. Baird

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

Jon Marten

Mig, 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. We, again, with less workdays 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 the heavy duty trucks. So, I think that all of those markets in North America are trending better mobile and 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 a color as to how the guidance was put together. Keep in mind, we are up sequentially in North America in Q3 and then up sequentially in Q4. Just to add to the all the other comments that we have made, keep in mind also as you are looking at the data for us that increased 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-à-vis the first half, so that 58-42 is we feel is very achievable. And that’s why we did the guidance the way that we did. So, I hope that helps.

Mig Dobre - Robert W. Baird

No, yeah it does. Thank you. And looking at Aerospace to 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?

Jon Marten

Could you just repeat the question?

Mig Dobre - Robert W. Baird

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 segment?

Jon Marten

Okay, yeah 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 our generally our lowest volume month. So, it just hit all of 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 are 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?

Don Washkewicz

Yeah, there are just a couple of extra comments I might make on the R&D spend, what are the challenges that we’ve had there is first of all just the number of new programs that we have. The good news is that we’ve got a number of these programs in the air now. Okay, the G650 that has been launched, the Legacy took its first flight that’s 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’s hard to predict frankly. And we found that 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, okay and that’s extremely important. What we are working on feverishly now is the Bombardier C-series and the Comac 919 and A350. We have got several of those and that’s the reason why we are still going to have a fair amount of R&D expense going forward.

But 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 this new technology as far as launching these planes. So, it’s really critical that you get your plane up and out and serve as our first flight when you say you are. Otherwise, you are going to have a real problem on the orders side of the equation. I am talking about our end customers now.

So, what impact does that have on us, lot of pressure to expedite R&D parts of the projects, where almost on a daily basis and there is a burn down tables and charts as far as different activities that have to happen within certain periods of time, and that’s all going forward. So, there is a lot of pressure, and that’s 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 properly. I think that’s going to help the customer certainly, that’s going to help us in the long-term. I think it’s going to help all the supply base and the industry when we do that, but that’s what’s that we’ve been faced with. So, as tough as it’s been to give you a hard number on R&D, it is tough, because everyday 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’s a little bit helpful for you to see what’s going on behind the scenes.

Mig Dobre - Robert W. Baird

Yeah, absolutely. And 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 and what you are guiding for?

Don Washkewicz

I think based on what I am saying some of these new programs that we are working on right now, the ones that were launched of course that’s 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’re probably going to always be looking somewhere in the 8% range probably could give or take a little bit on that, but it won’t be in the 12% plus or 10% or 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 we are at – 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.

Mig Dobre - Robert W. Baird

Thank you.

Operator

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

Andy Casey - Wells Fargo Securities

Thanks a lot. Good morning everyone.

Pamela Huggins

Good morning, Andy.

Andy Casey - Wells Fargo Securities

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 of destocking or something like that, that occurs in Q3, but not in Q4?

Jon Marten

No, I think Andy 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 the North America, but 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 also very slightly here for us. And we are starting to see some early signs of that as Pam alluded to earlier too here. So, yeah, there is not, we are really taking a look at the 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 trends going here in each one of our segment. So, it’s really that simple.

Andy Casey - Wells Fargo Securities

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?

Jon Marten

Yes, it includes it, Andy.

Don Washkewicz

Yeah.

Andy Casey - Wells Fargo Securities

Okay. So, second half much lower than first half basically?

Don Washkewicz

That’s right.

Jon Marten

Right.

Andy Casey - Wells Fargo Securities

Okay, thank you very much.

Don Washkewicz

Thank you.

Operator

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

Eli Lustgarten - Longbow Securities

Good morning everyone.

Pamela Huggins

Good morning, Eli.

Eli Lustgarten - Longbow Securities

Just a couple of clarifications. One, how big was the gain with the divesture in the second quarter?

Pamela Huggins

It was around $39 million.

Eli Lustgarten - Longbow Securities

$39 million, so that…

Pamela Huggins

Yeah.

Eli Lustgarten - Longbow Securities

And that just gets taxed at a standard rate or?

Pamela Huggins

Yeah, 38%.

Eli Lustgarten - Longbow Securities

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

Pamela Huggins

Yeah, that’s correct.

Eli Lustgarten - Longbow Securities

So, we had much weaker – without the gain, it would have been a much weaker quarter. Now, the R&D tax credit is going to be about 8…

Pamela Huggins

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.

Eli Lustgarten - Longbow Securities

Absolutely.

Jon Marten

Eli, Eli, one additional point here to make to, 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.

Eli Lustgarten - Longbow Securities

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

Jon Marten

$0.16.

Eli Lustgarten - Longbow Securities

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

Jon Marten

Also $0.16.

Pamela Huggins

Yeah, 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.

Eli Lustgarten - Longbow Securities

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

Jon Marten

Yes.

Eli Lustgarten - Longbow Securities

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

Pamela Huggins

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

Eli Lustgarten - Longbow Securities

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

Don Washkewicz

Actually, Eli 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’s 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 sometime, 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.

Eli Lustgarten - Longbow Securities

So, we are planning the rest of the year keeping the inventories relatively flat and so it’s…

Don Washkewicz

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

Eli Lustgarten - Longbow Securities

And I guess earlier question, I mean, we talked 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?

Pamela Huggins

That’s right, little higher than 40% international, but yeah, you are right Eli.

Eli Lustgarten - Longbow Securities

Yeah, I just want to make sure we are doing that. And 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?

Pamela Huggins

That’s right.

Eli Lustgarten - Longbow Securities

Right, thank you very much.

Operator

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

Ann Duignan - JPMorgan Securities

Hi, guys good morning.

Pamela Huggins

Good morning, Ann.

Ann Duignan - JPMorgan Securities

Hi. 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 or was it a bit of both or what exactly did you mean by those comments?

Don Washkewicz

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 slowdown, I won’t say one to zero, but come about mid-month, 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 that’s my inclination anyway. I think everybody was just on the edge of their seat wondering what the heck is going to happen in Washington DC. And so it’s a little bit of a paranoia from that standpoint.

Ann Duignan - JPMorgan Securities

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

Don Washkewicz

Well, I would say positive, I think in both areas I think positive. And I 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 was our farm and ag process, oil and gas, and commercial aerospace OEM.

Ann Duignan - JPMorgan Securities

And any end markets incrementally weaker?

Don Washkewicz

Yeah, I 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’ll give you those, cars and light trucks, power gen, semicon, life sciences, heavy duty truck, industrial refrigeration, and commercial aerospace aftermarket. That’s kind of the lay of the land right now.

Ann Duignan - JPMorgan Securities

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?

Don Washkewicz

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 that I wouldn’t have anything else to add.

Pamela Huggins

You know and 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 the Aerospace to continue to be strong, but the orders were very nice this quarter.

Ann Duignan - JPMorgan Securities

And were those aftermarket or OE?

Pamela Huggins

They – actually, we received some orders for military OEMs, F-15, F-18 type of thing. So, maybe everybody is trying to rush ahead of any type of sequestration, we’ll see, but thanks Ann, thank you very much.

Ann Duignan - JPMorgan Securities

Okay, thanks.

Operator

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

Jeff Hammond - KeyBanc Capital Markets

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

Jon Marten

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’s what we are expecting.

Jeff Hammond - KeyBanc Capital Markets

And what’s the reasonable timeframe to…

Jon Marten

I think we’ll start to see those levels here in the 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’s the trend that we are going to see.

Jeff Hammond - KeyBanc Capital Markets

Okay. 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 or do we take a pause here or do we still see quite a bit of activity?

Don Washkewicz

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 this, we got a little breathing room here. So, the key is to really get these acquisitions digested that we have already made these eight, eight that we have 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.

Pamela Huggins

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.

Operator

And the final question will come from the line of Nathan Jones with Stifel Nicolaus. Please proceed.

Nathan Jones - Stifel Nicolaus

Good morning, everyone.

Pamela Huggins

Good morning Nathan.

Nathan Jones - Stifel Nicolaus

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?

Don Washkewicz

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’s 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 am not against repurchasing shares and we have done some of that and we’ll constantly look at that. We are also looking at the dividend again right now as well.

Nathan Jones - Stifel Nicolaus

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 impacts you are seeing from stimulus efforts over there or what it is that’s giving you a little more confidence in China now than you seemed to have last quarter?

Don Washkewicz

But 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’s just a gradual positive movement at least some input that we are getting indicates some positive movement there. But nothing that’s going to be – it’s all in our forecast, it’s all in our guidance already, but it’s better than what we have heard in the last year, at least the tone is better than what we have been hearing.

Nathan Jones - Stifel Nicolaus

Alright guys. Thank you very much.

Pamela Huggins

Thank you. So, this time Don we’ll move to closing comments. And prior to that, I just want to say thank you. And Don?

Don Washkewicz

Okay. Well, thanks to everyone that’s 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, lot of activity going on with acquisitions, 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 the 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 are 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.

Operator

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

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