Good day, ladies and gentlemen, and welcome to the second quarter 2015 Parker Hannifin Corporation earnings conference call. My name is Katina, and I will be your coordinator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call Ms. Robin Davenport, Vice President, Corporate Finance. Please proceed.

Thank you, Katina. Good morning, everyone, and welcome to Parker Hannifin second quarter fiscal year 2015 earnings release teleconference. Joining me today on the call is Chairman, Don Washkewicz; our newly elected Chief Executive Officer, Tom Williams; and Executive Vice President and Chief Financial Officer, Jon Marten. Today's presentation slides together with the audio webcast replay will be accessible on the company's investor information website at www.phstock.com for one year following today's call. On Slide 2, you'll find the company's Safe Harbor disclosure statement addressing forward-looking statements as well as non-GAAP financial measures. Reconciliation for any reference to non-GAAP financial measures are included in this morning's press release and were posted on Parker's website, at www.phstock.com. So moving to Slide 3, our call agenda is outlined. We'll start with Chairman, Don Washkewicz, as he provides highlights for the second quarter. Secondly, Parker's newly elected Chief Executive Officer, Tom Williams, will make some introductory comments. Following Tom's comments, I'll provide a review of the company's second quarter performance together with the revised guidance for fiscal year 2015. Following our prepared comments, we'll open the call for Q&A session. And finally, Don will conclude today's call with some closing comments. So at this time, I'll turn it over to Don and ask that you refer to Slide number 4.

Thanks, Robin, and welcome to everyone on the call. We certainly appreciate your participation today, especially in light of the fact that you're digging out of a massive snow storm, especially those up in the Northeast and Boston, in particular. So we appreciate you're participating today. I'll take a few minutes to talk about the quarter, before I introduce Tom Williams, our new CEO, to make some additional remarks. First, a few comments on our second quarter. We had a record second quarter. Our earnings per share exceeded our expectations and has led to a solid first half and continuing positive trends for the company. While we are facing challenges in certain regions and end-markets, especially with respect to currency headwinds, we continue to execute well on what is a moderately positive economic environment. As you can see by the numbers, the benefits of our timely global restructuring executed in the past 18 months are helping to offset weaknesses in some of the regions and end-market segments, and we'll get into that a little bit later. Having said that, we are confident in our ability to achieve another year of record results, as outlined in company's guidance for the year. So here are some second quarter highlights. Sales were up 1% for the quarter, as strong organic growth of 4% was partially offset by significant currency headwinds. So you can see that the impact of currency was very dramatic, greater than I have ever seen in the past in this position. Order rates remain positive at 4% with growth in every segment. This is the sixth consecutive quarter of positive order growth, so we are very excited about that trend as well. Segment operating margin was 13.7% or 14% as adjusted. We are very pleased with these margins, considering that…

Thank you, Don, and thank you to everyone for joining on the call today. I am honored and excited to be the new CEO of Parker. I'd like to take this moment on behalf of all of the Parker employees to thank Don for his great leadership as CEO and President of our company. His vision and his passion have completely transformed Parker and yielded significant improvements in our results over the years. I really like our new leadership structure. As most of you know, Lee Banks and I have worked closely together, as the two Operating Officers for the company. I look forward to continuing to work side-by-side with Lee, as each of us take on our new roles as CEO and President and COO, respectively. In addition, we are fortunate to have a talented and deep leadership team that do a great job executing the win strategy. My near-term goals are, first, to continue with the performance improvements that are underway and deliver on our financial commitments for this fiscal year. Second, to execute our current capital allocation strategy of increasing annual dividends, investments for organic and acquisition growth and share buybacks. The win strategy will continue as the business system and overarching strategy for the company. However, with new corporate leaders, it is an opportune time to refresh the win strategy. Over the next several months we will be listening and assessing, as we formulate more detailed long-term plans for our company. Our goal is to take the win strategy and the company's performance to the next level. Don's leadership and the win strategy have positioned Parker well for future growth, and it is now my job to build upon the success and reinforce our position as the leader in motion control technologies. I'll now hand things back over to Robin, to provide a closer look at the results.

Thank you, Tom. At this time, I'll begin to address the earnings per share for the quarter and ask that you refer to Slide 6. Adjusted fully diluted earnings per share for the second quarter were $1.84 versus $1.30 for the same quarter a year ago. This equates to an increase of $0.54 or 42%. This excludes restructuring, which originally planned at $0.08 was $0.04 in the second quarter and compares to $0.06 for the same quarter last year. On Slide 7, you'll find the significant components of the walk from adjusted earnings per share of $1.30 for the second quarter in '14 to $1.84 for the second quarter of this year. Notably, the key elements that contributed to the increase were, segment operating income of $0.21, reflecting improved performance across all of out segments. A reduced tax rate for the quarter that contributed $0.18, driven largely by the passage of the U.S. tax extenders bill, which afforded the company increased foreign tax credit and R&D tax credit. Significantly, lower other for the period contributed $0.15, which included lower stock-based compensation expense and a number of favorable one-time items. And the impact of fewer share outstanding that equated to $0.04, offset slightly by increased interest expense of $0.03. Moving to Slide 8. Total company organic sales in the first quarter increased more than 4% over the same quarter last year. There is minimal contribution to sales in the quarter from acquisition and currency impact was considerably larger than planned, which reduced reported sales by $108 million or 3.5% in the quarter. As shown on the bottom of this slide, total company segment operating margins for the second quarter adjusted for restructuring costs in the quarter were 14% versus 12.7% for the same quarter last year. Restructuring costs in the quarter…

[Operator Instructions] Your first question comes from the line of Jamie Cook representing Credit Suisse.

This is actually Ben Xiao on for Jamie. Best of luck to Don and congrats, Tom and Lee. So my first question is, can you just speak to order trends by month during the quarter as well as January in North America, Europe and Asia? Was it pretty consistent throughout or were there any specific months that were stronger or weaker than expectations?

I think for the quarter, for our Q2, the order trends came in as we expected. We had a very good October. We had a pretty good November, and then a very good December. So the trends in the quarter were not deeply changing from month-to-month, but we did have a very good December. So that's what led to our guidance that we ended up providing here for the balance of the year.

And then on the operating margin guidance, it looks like it's mainly currency that's impacting international. So I guess for North America the implied incrementals for the back half of the year are a bit lower than the first half. Are there any specific drivers behind that?

No, those are really the incrementals for North America. And you're right. First of all, you're absolutely right on international. It is almost all currency driving that change in the margins. But for North America there are certain types of R&D, certain types of investments, this is consistent with what our guidance was at the end of last quarter. And so there is not one particular item altogether, there is a series of different items built into the guidance for the second half that is impacting slightly the incrementals for North America, which are at all-time high Q2 returns.

Your next question comes from the line of Nathan Jones representing Stifel.

If I could just, the international growth has obviously been taken down primarily due to currency. Is there an organic part of that reduced guidance there or is it entirely currency?

Almost all of it is currency. We are seeing some organic weakness in China in the construction business going forward, and that's impacting the numbers a little bit. And also internationally in oil and gas that's impacting the numbers a little bit. But that's less than 20% of the guidance going forward here. It's almost more than 80% of the reduction there, Nathan, is currency.

Nathan, its Tom. Just to add onto that, we've seen from some of the construction OEMs that they are actually shutting down the whole month of January all the way to Chinese New Year. So that's what's impacting some of those numbers.

And then on the corporate expense, which obviously includes interest, which is going up from your previous guidance, that's still gone down $15 million overall. Can you talk about what's on the good side of that ledger?

Well, going forward on that is our latest analysis of all the lines in the income statement going for the next six months. And when we put them all together, Nathan, it's really primarily stock-based compensation. There is also some charges that we take at corporate that we won't need to take, that has to do with some really technical accounting work in terms of LIFO. So that's it in a nutshell. There's not one significant thing other than stock-based compensation.

And then just on the Diversified Industrial North America revenue growth rate, you took 50 basis points out of that at the midpoint. Is that primarily related to the oil and gas business in North America, is there anything else impacting that?

No, I think, overall, Don hasn't gone through the markets yet. But if we had to give one answer to it, it would be our viewpoint on the weaker oil and gas going forward and that is built into our second half. It is not a pronounced number at this point. We're watching it very closely, but that would be the major driver, Nathan.

Your next question comes from the line of Andrew Obin representing Bank of America.

Just a question on buybacks. So should we assume that the rest of the buybacks in the next 20 months will be completed, you'll do it and then you'll tell us the way you do it beyond $50 million a quarter, is that what we should be thinking?

That's correct, yes.

Can you guys just comment on the impact of oil on Parker's numbers? A, first, maybe talk about the negatives. I know we have a lot of questions from investors, as to what exactly your oil exposure is. There is a lot of debate there, and if you could walk us through that? And, b, the positive impact. How long do you think until we see the positive impact on spares in the aerospace business?

Andrew, just to start with oil and gas, and then I'll get to the aerospace later. Big picture, our most recent 12 months oil and gas exposure is about $800 million. That's about 6% of our sales, half of that is OEM, half of that is aftermarket. It is also almost half in North America and about 35% in Europe and the balance around the world. We feel really good about the diversity of our oil and gas exposure. Half of it being in the aftermarket gives us less variability that we think that we'll see there going forward. We've made great strides in our oil and gas exposure, bringing new technology, new innovation, new products to markets that have not seen our technology before. That's what's helped us really more than double our oil and gas exposure over the last five years. And we're making inroads in that market, because of the productivity and the savings that we're bringing to our customers. Now, of course, going forward we're keeping a close eye on how that market is going to trend. Right now, today, anecdotally of course, we are hearing some comments from our customers. It is not going to impact our Q3, and that's what's built into our guidance dramatically. We don't think that it's going to really have a dramatic impact in our Q4 either. We do feel like that, given our exposure, given our diversity and given the different types of upstream and downstream exposure that we have to oil and gas, that we won't be hurt as badly as you might think that we would, given the $800 million in sales in the past 12 months. So file that we are going to keep everybody updated each quarter going forward. And we know that we'll have an impact, but how big that will be is impossible to say right now. We are just going to kind of continue to update you as the quarters go on. So that's the big picture on oil and gas. On the aerospace spares, I think that in our guidance going forward we have a modest increase in our spares projected for the second half. There is no doubt that as time goes on that spares and repairs, as a percentage of our aerospace business, will increase. When that inflection point is, as to when it starts to ramp up dramatically, is a question of debate right now. It's certainly not in our FY '15. When we pull together FY '16 and we start really making our way through the OEM super cycle that we're in right now, we'll be able to really have a better estimate as many of the new aircraft start to order spares as they get more hours on them. So I think it is clearly a tailwind for us going forward.

The next question comes from the line of John Inch representing Deutsche Bank.

Can I just ask about the diversified industrial international margin update to guidance? I think, Robin, you said it was, the down shift was due to FX, but why would actually that impact margins? Doesn't FX convert at sort of the average margins, so that it should sort of provide a read-through at a constant basis? Or are your European margins higher in terms of where you're seeing the weakness or what? I'm not sure I really follow it.

Well, our FX, your right, it does convert at our average margin and so we are reducing our sales forecast going forward. We are seeing in our international business, John, some additional headwinds when it comes to reaching the sales goals that we thought that we would get and so we're not getting the absolute margins that we are looking for. But it is true that our margins are and our updated guidance are slightly down.

So Jon, so the drag is what, like as you called out, sort of the stoppage of construction. I'm assuming there's a mix issue then with respect to whether you're seeing disruption on your margins. Is that fair?

Yes, it would be in Europe. We have a very healthy oil and gas business in Europe and so that would be part of it. And also would be internationally in China with the additional issues that we are calling out here in the construction end-markets there too.

And then why is your tax rate going down 2 points? That seems like an awful lot. If international is a little weaker, doesn't international have lower tax rates, like why would the tax rate be going down 2 points?

Well, in our original guidance there are two things that are really driving that. One is the legislation that was passed in December and we've gotten a significant research and development one-time credit. We're also building in our tax rate the impact of the balance of the legislation and the extenders legislation that was passed. But also, we updated our guidance in terms of what our international income will be vis-à-vis our total income for the year. And when we did that it is counterintuitive, but when we did do that we did end up showing a larger percentage of our international income in our tax rate, therefore, driving down the overall tax rate for the company.

I guess I could take that offline, but is there any sound bite? Like how does that work? How do your international numbers go down, but I'm not sure I'm following that?

It has to do with the mix of income by country internationally, and I can explain that to you in more detail if you would like.

Your next question comes from the line of Joe Ritchie representing Goldman Sachs.

So my first question is really on the aero segment. It looks like you had really good organic growth this quarter, good margin expansion, but as you look into the back half of the year you're still expecting a pretty significant improvement on the margin. And so if you could just provide some color on what's going to drive that improvement; is R&D as a percentage of sales, still expected to be 9%? And are there mix issues that are going to benefit that in the second half?

We are seeing that R&D, as a percent of sales, is going to still be right around the 9% level here, so that would be our update for you today, Joe. I think that it is going to be additional volume through the second half that is going to drive margins further. It is also going to be a slightly better mix for us in the commercial MRO and business here vis-à-vis our OEM business going forward here too, which will be driving incremental margins for us.

And then I guess following up maybe on Nathan's question from earlier; is it typical to see Chinese construction OEMs basically shutdown spending this early ahead of the Chinese New Year?

Joe, this is Tom. No, that is definitely very unusual. Maybe they might extend it a week, but to extend it for that period of time is definitely unusual. That's one of the impacts we included in the international segment for the second half of the year.

And then maybe what if I could sneak in one last one on the buyback? If you could just kind of walk through your funding assumptions for the buyback, how much of the buyback or what percentage of the buyback can you fund through going out into the CP market versus free cash flow versus term debt, that would be helpful.

Joe, our intent is to have our CP market, our CP balance at zero by June 30. So we are going to be funding our additional incremental stock buybacks through operating cash flow.

And the debt that you called out at the end of last year?

Well, the debt that we called out at the end of last year was used to pay down, as Robin explained on the CP and that we had an outstanding, so.

Your next question comes from the line of Jeff Hammond representing KeyBanc Capital Markets.

So just a couple housekeeping items on the buyback. Can you give us ending diluted share count for the quarter and what your average price you paid for the $1.2 billion or so that you bought?

The average price that we paid for the $1.2 billion was $126.5. And the ending share count at the end of the quarter was 148.7 million.

And then maybe can you just address the M&A pipeline and if any of this market choppiness is likely to bring back any of these larger deals you had looked at.

Jeff, this is Tom. I would characterize the pipeline as kind of skinny right now; not as deep as we would like to have. Valuations continue to be high. However, our strategy is still to grow via acquisitions. And we've got a history of being a great acquirer and gaining a lot of synergies as we do that, so we will continue to do that. We do want to beef up that pipeline. That will be one of the things that Lee and I focus on is to increase that pipeline. I don't see here during the share buyback period us doing a very large deal. I think we are focus on our bread-and-butter acquisitions, the normal size you've seen us do historically. Maybe after that if it made sense and the right property came along we would look at it, but I think we'll focus on our space and the sizes you've seen us do in the past.

Jon, just back to the share count. I think you had 148.2 million for the average for the quarter. I'd expect that the ending would have come in lower than that, given the buyback activity?

Well, I thought that you asked for the period ending number there, Jeff, so I would have to get back to you on the average for the quarter. I can tell you this, the average for the year that is included in our guidance is 145.8 million.

Your next question comes from the line of Josh Pokrzywinski representing Buckingham Research.

Just first question here, I guess a lot of focus on the oil and gas business. Maybe if we can look at that from the other side in terms of price cost. Clearly commodities have come in across the board. You guys technically have pretty good pricing power through distribution. Is that something you factored into your guidance or something we should expect to see in this fiscal year?

As far as materials and price, maybe just step back for a second and talk about how we normally look at those. But we always look at Sell Price Index or SPI, and we look at purchase price index that we're paying coming in. And the goal is always to have that be slightly positive, which is what we have factored into the guidance. When I look at materials, it's kind of a mixed bag. We've got aluminum and zinc that are slightly bit plus, I'm giving you prices versus the prior year. On the negative side, meaning prices going down in castings, copper, but remember copper is typically indexed for a lot of our OEMs and flows through on pricing and material that happens. Nickel is soft. And then bar stock is flat. So it's kind of a mixed bag, but what's in the guidance is a slightly positive help with PPI versus SPI.

And then just a follow-up on the buyback. Have you guys been able to tighten the range on total purchase over the next 20 months or are we still sticking with that $1 billion wide range at this point?

The range is really going to be predicated by what other capital opportunities are out there, primarily acquisitions. So we are committed to the minimum side for sure, the $2 billion. But if we saw acquisitions that we liked, we would stay at the low end of that at the $2 billion. If there wasn't a lot of activity that we could action, you'll see us towards the top end.

So there is a commitment though to spend $3 billion in some way, shape, or form?

That's right.

Your next question comes from the line of Sara Magers representing Wells Fargo Securities.

This is Sara on for Andy Casey. I realized that you've probably talked a little bit about the components of the higher other income, but could you give a little bit more color as to the lower stock comp expense in the favorable one-time items and within Q2 and then within the guidance? And, if possible, the split for Q3 and Q4 in the second half.

Well, we see the split in Q3 and Q4 to be just about 50-50. The stock comp expense being down as we update our guidance just has to do with -- there's a lot of variables involved, but in general it has to do with our relative profitability, our relative profitability to our past, our relative profitability in accordance with our proxy peers. And it also has to do with how we are trending long-term over a three and four-year time period. We are constantly updating those updates in accordance with the plan determinations, and as we do that it's just incumbent upon us to keep the guidance updated. That line in our income statement can be quite variable over time, so we are just trying to give you the best information that we have today.

Your next question comes from the line of Jeff Sprague representing Vertical Partner Investors.

I was wondering if you could just address restructuring, a small change, but kind of with the challenging world a little surprised you dialed it back a little bit. Would that reflect that you are getting more bang for the buck or there's savings coming through at a faster rate? Maybe you could just elaborate there.

Jeff, I think the really key message there is that there were -- our European restructuring program is just about complete, so the dialing back of the restructuring program has more to do with projects that we had underway outside of Europe that were dialed in for our fourth quarter. And we didn't really have much savings built, any savings built in to our FY '15 that were going to impact FY '16. And those projects are moved out of our guidance and may or may not be in our FY '16 guidance. We have not made that final determination yet, but we'll update you then.

And I was just wondering on, maybe this gets to talking about some of the key verticals, but motion systems looks like it was relatively weak versus other parts of the portfolio. Could you address kind of what's going on there in the big buckets, ag, off-highway, other key drivers?

I will start on the technology platforms and I'll let Don go through all the markets. So first on the motion systems and really the flow of process control at the two technology platforms that were soft. If you look at all the platforms, they had the most exposure to some of the soft end-markets, farm and ag, construction and mining, so those are why those two are down. But then what did the technology platform show you is the power of the portfolio here, so engineered materials and filtration, and aerospace were positive offsetting that because of their exposure to automotive, telecom and of course, anything related to aerospace has been positive. Truck, marine and even with early signs in oil and gas, oil and gas is still positive year-over-year for us. So the motion and flow in process control, they were soft because of those ag, construction, and mining. But I'll let Don go through the typical market review.

Jeff, would you like a little color on the PMIs and some of the trends and order trends?

I think, we probably got our hands on the PMIs pretty well, but any vertical market color would be helpful, yes.

Maybe I will start with the regions. If we look at Industrial North America, the way I would describe it would be moderately steady growth there. 3/12 order trends north of 100, at about 104; 12/12 running about 105. So Industrial North America pretty consistent with what we have been talking about as far as our order activity here has been moderate, steady growth and it has been positive. Europe is flat, 3/12 100 to 101 in that range, pretty flat. 12/12 running about 100, which means there is virtually no growth in Europe currently. So that's what is happening there. By the way, that does not include the headwind from the currency. This is just the underlying growth of the region. Slower growth in Asia, 3/12 running about 102; 12/12 still at 107, so we would expect the 12/12 to trend down slightly over the next several months. And we'll be updating that as we go forward. Then declining growth in Latin America, we talked about that before. Latin America is one of the toughest regions out there right now. We have a smaller position there, but it's still a tougher region, 3/12 running about 90%. And then I want to just comment a little bit on some of the key markets in the same fashion that I have in the past. But one thing that I do want to point out and that we tend to overlook in many cases is our distribution channel. That is one of the strongest segments we have of all segments. It represents half of our industrial business. 3/12 trend on distribution alone is running about 110%, which is extremely strong. 12/12 is running about 110%, so here is a segment of our business that's just going full blast and doing extremely well.…

With no further questions at this time, I would now like to turn the call back to Ms. Robin Davenport for closing remarks. End of Q&A

Thank you, Katina. This concludes our Q&A session. At this time, I would like to turn the call over to Don for his closing comments.

Thank you. Just a few closing comments. First of all, I want to again thank everyone on the call for joining us this morning, especially in the tough environment that you have out there for those up in the Northeast of course. I also want to thank you. I heard a lot of congratulations on the phone and I just want to thank you for those congrats, both for Tom and Lee and myself in our new assignments. I have certainly enjoyed participating on our quarterly calls over the past 15 years. Fortunately for Parker and our shareholders, they have been some of the best years in the company's history. With Tom and Lee now at the helm, I am totally confident that they will continue the momentum we have established and improve upon the successes we have had. I am pleased to end on a positive note as we anticipate that fiscal '15 will be a record year and that we will exceed our much sought after goal of 15% segment operating margin over the cycle. As always, I will take this opportunity to thank our employees, our global employees, our global workforce for their continued commitment and success, not only today, but during all of the years that I have led Parker. Our global team has done an amazing job executing the win strategy and delivering positive year results year-over-year. My best wishes and thanks to all of you in the financial community for your support of Parker. I look forward to continuing to serve our shareholders, along with my fellow directors and our new management team as Chairman of the Board. Of course, if you have any additional questions, Robin and Todd will be around for the balance of the day. And so with that, I'd just want to once again thank you and have a great day.