Parker Hannifin Earnings Call Insights: Decline in Margins and Current Guidance

Parker Hannifin Corporation (NYSE:PH) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Decline in Margins

Jamie Cook – Credit Suisse: I guess two questions. One, if we look at your guidance for North America and for international, you’ve taken your revenues up a little relative to your previous forecast the margins are down a little. I’m 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 other potential tail winds 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.

Pamela J. Huggins – VP and Treasurer: Just to clarify, at the midpoint, last guidance to this guidance we did take North America up in revenue, but on International we did take revenue down, and then you’re exactly right, Jamie, to your point, we did take segment operating income down in North America and International. Jon, do you want to…?

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Jon P. Marten – EVP, Finance & Administration and CFO: Yeah, I mean Jamie, just to the point of your first – in terms of the headwinds and the tail winds from a pricing in 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 time frame 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 our suppliers to help us with as time goes on. Now, in North America, that is also being impacted by the acquisitions and as Don alluded to earlier, the margins are being impacted by the reduced organic sales being replaced by acquisition sales are coming in at lower margins than we were seeing on the organic business that is moderating as time goes on. 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 summary the way that we are looking at margins going forward here for the second half.

Jamie Cook – Credit Suisse: 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? 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 cost?

Pamela J. Huggins – VP and Treasurer: Yeah, let me give you couple of margin return on sales numbers without the acquisitions, I think, it might help. North America for the second quarter, while the margin return on sales was unfavorable, if you exclude the acquisitions you are within 30%. You are around 30% which is what our target is. International, the same thing; if you exclude acquisitions, not quite as good as North America but it is in the 40% range. So, we are very cognizant of that. 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: Pam, just to clarify. So, the margin improvement back half versus first half it is all volume?

Pamela J. Huggins – VP and Treasurer: 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.

Current Guidance

Joshua Pokrzywinski – KM Partners: 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’re 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 P. Marten – EVP, Finance & Administration and CFO: In total for the year, 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.

Joshua Pokrzywinski – KM Partners: So that $0.06 to $0.07 is incremental versus the last time we spoke a quarter ago?

Jon P. Marten – EVP, Finance & Administration and CFO: No.

Pamela J. Huggins – VP and Treasurer: Well, last time we said $0.05 to $0.10, but we weren’t thinking that it was going to get to the upper end of that. Now we think that it is.

Joshua Pokrzywinski – KM 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 P. Marten – EVP, Finance & Administration and CFO: Yeah, I think that’s fair. I think that’s a fair analysis, that’s not bad at all.

Joshua Pokrzywinski – KM Partners: Just thinking about cadence through the quarter, obviously October was pretty bad from when we spoke last quarter. Can you give us a sense of how things faired in November and December just on an order base, if I understand the 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 J. Huggins – VP and Treasurer: Well, let me just give you a little color that I have, okay, and then Don and Jon can add on as 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 tell you is that in North America, the trough was really in August and September. So, when you look at the percentage decline year-over-year, the trough really took place in August and September and obviously getting better from there. Europe, we actually saw some sequential improvement in the second quarter, Asia continues to be pretty weak for us, I’m hopeful that we’re going to see something as we move out and I think everybody else is hopeful and I think in January, we’re 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?

Joshua Pokrzywinski – KM 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’m reading that right?

Pamela J. Huggins – VP and Treasurer: I think that’s a good read.