派克漢尼汾 (PH) 2005 Q3 法說會逐字稿

Good morning. My name is Shayla, and I will be your conference facilitator. At this time I would like to welcome everyone to the Parker Hannifin third quarter 2005 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS] Thank you.

Ms. Huggins, you may begin your conference.

Thanks, Shayla. This is Pam Huggins speaking. Good morning. Welcome to Parker-Hannifin's third quarter teleconference. Once again, as is customary, I have a couple of comments prior to commencing with my prepared remarks.

First, the slides that you see today, that we will be using, will remain on Parker's website at ph.com until the next earnings release, along with the webcast of the teleconference itself. Second, upon commencement of the question-and-answer session, to be held at the end of my prepared remarks, I would ask that you limit yourself to one question at a time in order to give everyone a chance to participate. I would like to once again call your attention to the disclosure on forward-looking statements. Periodically updates are made to this statement, so please read it in its entirety.

As a reminder the numbers that we will be presenting today are on a GAAP basis, with one exception. That exception relates to sales. The sales numbers have been reconciled from a GAAP basis to that without acquisitions and divestitures and currency, to allow for a valid comparison from period to period. The other thing that I would like to mention is when we get to the Q&A session today I will have Timothy Pistell, our Chief Financial Officer, will be joining us, as well as Don Washkewicz, our Chairman and Chief Executive Officer.

Also, as customary, I won't be reviewing each slide in detail but will focus on the highlights only. As a brief review of the agenda, first I will begin with the summary of the earnings per share results for the quarter and year-to-date. I will then address the sales growth for the quarter and on a year-to-date basis. I will also have a few comments on the influences to sales, specifically the order information. And then I'll follow with some comments on earnings and the effects of the Win Strategy.

Briefly, segment results will be summarized for the quarter, and then I will conclude with a quick overview of the balance sheet and cash flow position, and close with the outlook for fiscal year 2005. With all those housekeeping items aside and out of the way, I will now begin with the actual earnings release. In line with the press release this morning third quarter earnings from continuing operations came in at $1.18. This $1.18 is 34% higher than the earnings per share of $0.88 for the same quarter a year ago. Remember, this $1.18 includes a tax benefit of $0.10 and a charge of $0.06 for realignment, a divestiture, and tax consulting fees. Including a $0.03 charge from discontinued operations, diluted earnings per share was $1.15.

Now looking at EPS on a year-to-date base, earnings per share from continuing operations is up 78% from $1.80 to $3.21. Diluted earnings per share on a year-to-date basis is $3.68 as it includes $0.47 from discontinued operations. Income on a segment operating income basis for the quarter increased 32% from 10.3% to 12%, a 170 basis-point improvement. Looking at sales for the quarter, they were up 15% -- or 14%, excuse me, over last year. Of this 14% sales growth 7% came from acquisitions, while 2% was the result of foreign currency, mainly the euro, leaving 5% growth from our core businesses.

Turning to significant influences on sales the 14% sales growth, which is on top of 16% last year, is the result of continued industrial end market strength in most of our markets. Mobile, heavy-duty, truck, oil and gas, just to name a few, continue to be strong. Adding to this is the successful integration of the recent acquisitions, namely Sporlan and Acadia. Aerospace continues to show strength in the commercial original equipment market, and defense remains stable. While North America continued to be the main driver of sales growth for the Company, Parker continues to see strength in all regions.

Moving to the order trends, starting with North America, order rates have been positive for 19 consecutive months, and while we have bumped up against some tough comparisons orders remain very strong. The 5% growth that you're seeing again is on top of 24% last year. Next month we'll see an unusually tough comparison as orders were up 25% last year at this time.

Moving to rest of world, orders again have improved year-over-year for 19 consecutive months. The 4% increase in orders that you are seeing for the most recent month is on top of 16% last year. Softness has been seen in Latin America due to agriculture, mainly Brazil, and while softness has been seen in China due to mobile, it appears to be a little unpredictable and already has strengthened slightly. Europe, while muted, continues to do well in certain regions. Specifically, Sweden, Finland, Germany, and the Netherlands are strong. Italy and Spain, while soft, have shown improvement in the last couple of months.

Moving to Climate and Industrial controls, orders there, as you know, tend to be lumpy. However, Auto continues to be very soft. Helping this group, however, is the newly acquired Sporlan business and strength in Refrigeration and Air Conditioning. On the Aerospace side, orders continue to be encouraging reporting a 12% increase and this 12% is over 11% last year. Defense is stable, along with the aftermarket side of the business. Again, the strength that you're seeing, 12% above 11% last year is the commercial OEM side of the business.

Focusing on earnings for a moment, for the quarter, net income is up 29%, and income from continuing operations is up 34%. On a year-to-date basis net income is up over 100%. North America earnings are 36% higher and international earnings are 47% higher than last year. While Aerospace didn't see these same types of increases their margins are high at 14.5% for the nine months just ended. Climate and Industrial controls increased earnings for the quarter by 24% despite a significant slowdown in the automotive market.

Increased earnings in the different segments are due to increased volume, running higher volume through less facilities and the Win Strategy. This can be seen on the gross margin line pushing up 120 basis points for the quarter. The results of the Win Strategy continue to be seen as margins increase over 200 basis points in North America and rest of world. The soft Automotive business can be seen in CIC's results offset by strong Refrigeration and Air Conditioning markets and the Sporlan acquisition. On the inventory front DSI decreased 6 days over last quarter and productivity improved 7% over the same quarter a year ago.

Now I will move to the segment information, but I will be brief. Starting with industrial North America, sales growth for the third quarter was 8% over a year ago. Acquisitions added another 4%, and foreign currency added 1%. Resulting in a 13% total sales growth for the quarter. This compares to a 19% sales growth on a year-to-date basis.

Moving to rest of world, sales increased 4%, acquisitions added another 6%, and foreign currency mainly the euro, contributed another 5%. Resulting in a total sales increase of 15% for the quarter. Margins in rest of world moved from 8 to 10% for the quarter, a 200 basis-point improvement.

Now moving to Aerospace, Aerospace sales increased 7% for the quarter while margins remained flat at 13% from the same quarter a year ago. Again, this is mainly the result of mix moving more heavily toward commercial OEM markets. Climate and Industrial controls, while sales decreased 2%, again, due to the automotive that we talked about earlier, acquisitions contributed 25% and FX contributed 2% resulting in a total sales increase for the quarter of 25%. Operating margin increased $6 million in the third quarter and as a percentage of sales remained flat at 12%. Again, what you're seeing is a soft automotive market that we've been talking about, offset by strength in Refrigeration and Air Conditioning.

Moving to the other segments, on 11% increase in sales, margins improved 800 basis points. This segment, as you recall, reflects the divestiture of Wynn's specialty chemical which is included in discontinued operations.

Now at this point I will move to the balance sheet and touch on the highlights there. Parker's balance sheet remains strong. Cash on hand at quarter end was 104 million, fairly flat with last quarter, mainly as a result of the acquisitions made during the quarter, and the pay-down of debt. No commercial paper is outstanding at the end of the quarter. On a working capital basis as a percent of sales, it's down. DSI is down six days from last quarter, and DSO is down three days from the same quarter a year ago. Capital expenditures are still running at approximately 2% of sales. Depreciation continues to run ahead of the Capital Ex by about a percent. Debt in the quarter has been reduced by 151 million as I mentioned earlier, and the debt to total cap is down to 22%. So Parker continues to have strong cash flow and if continued at this pace, will have a record cash flow year.

Now turning to the forecast for fiscal year 2005, I'm going to round here just to make this fairly simple. And the percentages that I'm going to give you for the increase in sales are obviously over the 2004 numbers. So North America sales are expected to be up around 16% for the year, industrial rest of world sales should be up in the neighborhood of 20 to 21%. Aerospace, sales will be up 10 to 12%. Climate and Industrial controls will be up 19%. Again, that's the result of Sporlan. The other segment is forecasted to be up 10%.

And then moving to an operating margin basis, operating margin for 2005 over 2004 for North America should be up in the range of 330 to 360 basis points. Industrial rest of world, just rounding, at about 260 basis points. Aerospace, 150 basis points. Climate and industrial controls, down 50 basis points, and then other up 530 basis points.

Going to below operating margin, corporate administration, it was -- last quarter the guidance was $0.05 to $0.06 per quarter. We said up that would be up 5 to 6% for the year. We are now saying down 2 to 4% that is mainly the result of incentives. As you know we have incentives that are tied to the stock price, with a decrease in our stock price it is now forecasted to be down. Interest expense, down 7 to 9%, in line with what the guidance was last quarter, so no changes on that line.

Other expense income, however, is forecasted to be up 230% to 250%. I just want to spend a minute talking about that particular line item. Last year we had some gains on the sale of a couple businesses that had been included in Other expense. So when we went into this year, immediately we had an increase in that particular line item just as a result of excluding those gains on the sale of the two businesses. Then in the first quarter we had the pension curtailment and the investment write-off, which amounted to $0.07. So the forecast, with respect to other expense, was increased at that time based on those items. It is now being increased further due to LIFO as a result of the raw material price increases our LIFO adjustments have been fairly significant in the third quarter.

The other thing is that the, you know, in some respects the estimate was based on the prior year run rate, not the current run rate, and some additional expenses kicked in. I.e., the expenses that I've just mentioned. So that is -- that will be up significantly for the quarter. For the full year, we expect to do about $4.72 to $4.92. So we are expecting a slightly better quarter in the fourth quarter versus the third.

Just in summary I would like to say that sales were up in the quarter by 14%, earnings per share from continuing operations was up 34%, cash flow continued to be good, providing the capability to grow our business through acquisitions and organically. The focus obviously remains on inventory reduction where with DSI coming down six days from last quarter, productivity is up 7% from the prior year. Our orders and backlog remain at high levels and again as I just said fourth quarter is projected to be slightly better than third quarter.

At this time I would like to conclude with my prepared remarks, and open the conference up to questions and answers. And again, I would just ask that you please limit your questions to one at a time so that we can give everybody a chance to participate in the conference. Thank you.

[OPERATOR INSTRUCTIONS] Thank you. Your first question comes from Robert McCarthy of Robert W. Baird.

Good morning, Pam.

Hi.

Hi. I wonder if you could expand on your comments about the market environment in Europe. You talked a little bit about Germany, Netherlands, certain Scandinavian markets being strong, southern Europe weak but getting better. Importantly, you left out U.K. and France.

Okay.

Can you also, as you do this, can you distinguish between whether you're talking about mobile markets, overall, et cetera?

Sure. Let me run through -- first of all, let me run through the countries, then I'll loop back and talk about the markets. What we're seeing, believe it or not, Germany, Germany continues to be strong for us. I know that the, IFO when you look at it, has been ticking up in the last couple of months but it still isn't above 100, but Germany for us has been relatively strong. France has not, on the other hand, and then U.K. -- and I address those three because those are the three biggest countries that we have -- in Europe, U.K. tends to be what I would just phrase okay. Italy is soft, Spain is soft, although Italy and Spain both have seen some increases in the last couple of months.

Now, looking at it from other places that are strong, Sweden. Sweden is very strong from a wind power standpoint. Netherlands, as I said, is strong as well. Looking at it from a market standpoint, though, Europe tends to be very strong in the farm and ag areas. It also is strong in construction, but it isn't strong in general industrial.

General industrial in North America is much stronger than what we're seeing in Europe. Distribution in North America is much stronger than what we're seeing in Europe as well.

Does that mean that distribution in Europe is, what, flat?

No, it's up, but it's not up to the extent that distribution is in North America.

Okay. And just to clarify, when you were talking about France, you're seeing it weaken? Is that --.

right.

All right. Thanks a lot, Pam.

You're welcome. Hello?

Yes. Your next question comes from David Raso of Citibank Smith Barney.

What has changed in the outlook from three weeks ago, when you issued your previous earnings guidance? What's been the change to raise the guidance after having lowered it a few weeks ago?

I think that's a good question, David. When we went out, I think we said -- we're at $1.18 from continuing operations, and we weren't quite that positive in the press release when we went out. In Parker, whether we like it or not, March makes up a significant part of the quarter. And, you know, March came in a little better than what we expected for the month. So -- and at the time that we went out we really didn't know that. Now, --

David this is Tim. When we did that announcement, we had to do several things. First of all, we had warned you that there could be some realignment and also some tax benefits if certain actions went forward. So we had to give -- we did have that tax credit, we did have that realignment. We wanted to get that information to you prior to the call.

And the other thing is that we were sitting there with -- we had put a range out there. The midpoint was $1.20. The Street was sitting at $1.24, and, you know, we just -- we didn't think we'd get there. And, you know, we -- so we thought we'd have a good March, we didn't know how good, so we had to recalibrate. So I think it's as simple as that, really. Not any more complicated than that.

I was just thinking, given the pre announcement was on the 28th, I believe, there was only a couple days left in the quarter, I suspect you had a decent handle on March. I'm just trying to think which end markets changed your view of your outlook?

I don't think any end markets did. Again, we had to lower the guidance. We lowered the guidance. We clearly were going to try to come up with a range that we will this time, you know, meet or beat, and so we were kind of in that gray zone. But we felt it was an obligation to communicate those discrete items and also recalibrate and again as Pam said, March did then, you know, surprise us pleasantly that things came in, you know, a little better than we had even thought then. But it wasn't any more complicated than that.

I guess, Tim, just given your years before Pam on the Investor Relations side, just kind of interesting that late in the quarter for three weeks later, you know, fairly notable change in the guidance. I'm just trying to think through what -- what should we take away from future guidance with two or three days left in the quarter the number still comes out pretty different than the pre announced level.

What you can take away from that, the fact that -- and I remind you back on the second quarter, you know, we hit our number. We essentially hit our number, but the Street was $0.07, $0.08 above us, and that was not a pleasant experience. We could have been relatively close, maybe, to the number, but we weren't going to get to the $1.20. The Street was ay $1.24. We had to recalibrate. We had to give you discrete information, and we had to recalibrate. So it is not that exact of a science. We do not control the numbers here. You kind of -- we have to close the books and see how they come out. But we felt that, an obligation to recalibrate, and that's where we were.

Last point, I guess, is with Aerospace not mentioned in the pre announcement, when, in fact, that having, you know, a fairly notable sequential decline in profit, if anything I would have thought that would have hit the radar screen on a pre announcement, but it didn't.

Aerospace is performing exactly in line. We told you at the beginning of the year that they started out with a great beginning because they had a high content of MRO. And we told everybody that in the second half, that that was going to change. There would be a mix change, and the top line would look pretty good, and -- but it would be -- there would be a big mix change in that we were going to crank up on the OE side. They were losing some of the MRO, and the margins have been absolutely in line. Aerospace is performing just as we always expected.

So at this kind of mix going forward think kind of flattish to maybe up slightly margin?

Well, I think for this fiscal year we'll have to see for next year, of course, but for this year, this is going to be what it is through June. I think there could be some up side for us next fiscal year but it's too early to tell. We don't have those forecasts in hand or signed off yet.

Thank you very much.

All right.

Thanks, David.

Thank you. Your next question comes from Mark Koznarek of Midwest Research.

Good morning, Mark.

Hi, good morning. You know, actually, David just asked the question among several others of Aerospace, with regard to whether this 13% is a reasonable ongoing outlook, and it sounds like Tim suggests there is a bit of up side potential as we get into next year.

Well, I said we don't know that yet but I think that, yeah, I did say I thought there could be. We're -- hope that the aftermarket piece could pick up again a little bit, but, again, we don't have that yet, Mark, so don't say I said that but I think there could be. But where we're at is where we're going to be for the fourth quarter.

Well, maybe one thing that would help, is where do we stand with regard to the split of defense versus commercial, and OEM versus aftermarket right now, and where is it normally for Parker?

Mark, you know, we talk about this a lot, and basically, the commercial and defense are segregated about 50/50. And then the OEM is about 55, with the aftermarket at 45. So and really that mix isn't significantly different. They have switched to you know, the commercial OEM side is coming on a little bit stronger, but there's not a significant difference in that.

So just some modest changes in percentages can make a big difference in margin here?

Right.

Especially between the -- certainly, as you know, between the OE and the aftermarket. Historically, Mark, you've been following the Company a long time, you know that in the 80s, in the Reagan years, we probably had 60% military/40% commercial, then we went in the '90s more -- we flipped the other way. It was more 60% commercial, 40% defense. Now under the current environment we're -- we've got this kind of 50/50. So that's sort of the relevant ranges, but it's not so important between the commercial defense, as it is between the OE and the aftermarket. As you know, that's where the margins are, in the aftermarket.

So it sounds like the probability is the OE stays pretty strong as commercial builds continue to increase as we go through this year and into next.

I think that's a fair statement.

Okay. Good. Thank you.

Thank you.

Thank you. Your next question comes from John McGinty of CSFB.

Hi, John.

Good morning. Let me come wack to the question of the guidance versus the actual, and ask it a slightly different way. Midpoint of guidance was $1.10. You came in at $1.18. I understand the difficulty in forecasting and the reasons that you did it. But can you give us just a flavor for relative to what you were expecting, was that $0.08, for example, all in North America in industrial? Was it split evenly across the board? Where were the surprises in the last three weeks relative to what you thought three weeks -- or on the 28th of March?

Well, you know, to throw out a couple of areas, we normally don't like to talk in this detail, but our hydraulics business in Europe is very strong, and our instrumentation business, which, you know, there's a certain part of it in micro-electronics where that business is very soft, but in spite of the softness we've been able to keep margins at a relatively good level. So there's a couple of areas that did a little better than what we really expected.

Just the follow-up question was, if we go back to the midpoint of your guidance that you gave then and the midpoint of your guidance that you gave now, the midpoint to midpoint is up about $0.09, $0.08 though was in the first quarter. So what you are saying is that the things that occurred better in the last three weeks you're not thinking of March being any kind of a trend, you're leaving your guidance exactly where it was three weeks ago, essentially except for the beep that you had in March.

Right.

Because none of it carries over?

You're talking about fourth quarter?

Exactly. In other words, if March is better than you thought it was going to be, but you're just saying right where you were three weeks ago.

-- carrying into fourth quarter. If you look, I think it is, I think it absolutely is. If you look at third quarter and compare to fourth quarter the margins are actually going up.

No, but I'm talking about versus your guidance, Pam. I'm not talking about versus the business, I'm talking about versus the guidance. The guidance has not changed in the fourth quarter.

No, the guidance has changed a little bit.

By a penny from midpoint to midpoint from three weeks ago.

Right. But we had taxes -- think about it, John. We add big benefit from taxes this quarter.

No, but that was in the numbers three weeks ago, as well.

Well, if you look at guidance to guidance, previous guidance to this guidance --.

from three weeks ago to this one --

The real difference is rest of world. The real difference in the previous guidance to this guidance is the rest of world. Our previous guidance had it at like 14 to 15.5, and now it's going up to --.

20 to 21, and that's all organic? That's no acquisitions?

For the most part. What that is is a couple of of things. It's the strength that we're seeing in Europe. It's also, I would say, a little bit of a makeup from the previous guidance. As you recall last quarter on the teleconference, people indicated that rest of world was too low.

Okay.

So there's a little bit of makeup from that, and it's also reflecting the strength that we're seeing.

I'll get back in queue.

The second thing is previous guidance was at about 14.8% I think in the sales line, now it's up to 16.7. Again, I just want to reiterate that the biggest portion of that is rest of world. Okay, John?

Thank you, Pam.

Thank you.

Thank you. Your next question comes from Gary McManus of JP Morgan.

Good morning, everybody.

Good morning.

If I look at your current guidance for fiscal '05, it's $4.25 to $4.45 if I strip out the discontinued. And you did $3.21 for the first nine months so it suggests a fourth quarter of $1.04 to $1.24. Am I doing that right?

What's your range?

For fourth quarter, $1.04 to $1.24.

You're in the ballpark.

Okay. In the third quarter, -- when you said, Pam, you said a couple times you expect the fourth quarter to be slightly better than the third quarter. The third quarter you did $1.18. I'm not sure if you're excluding the tax benefits and realignment charges, but it looks like the official fourth quarter guidance of $1.04 to $1.24 doesn't necessarily assume that the fourth quarter would slightly beat the third quarter, as you said, in your prepared remarks.

Let me just clarify this. We did $1.18. Once you add back the $0.03 from discontinued operations it gets you to $1.18. If you normalize that, though, taking out the tax benefit, adding back the realignment of $0.06, it's $1.14.

But still, that's in the midpoint of your $1.04 to $1.24 estimate. And you said you expect this fourth quarter to slightly beat the third quarter.

In the fourth quarter my midpoint is a little above $1.14, and that's the result of obviously taxes are going to be higher in the fourth quarter because we're not going to get the same benefit that we had, but Aerospace and CIC are both projected to be up somewhat. So the margins actually increase on the operating margin line a little bit, but then we lose it on the tax side of things.

Okay. I just want to make sure, when you say the fourth quarter should slightly beat the third quarter you're just looking in the midpoint of the fourth quarter range?

Right.

Okay. Because, I mean, you have a $0.20 range in your fourth quarter guidance.

Right. I'm just saying, hey, from a mid-point perspective.

That's helpful. Another question I had, you changed the corporate admin expectations, which I think you said was mostly because of lower incentive comp.

Right.

Was that a factor on why the third quarter came in above your -- your guidance three weeks ago, and is that -- it seems to me that's adding about a nickel to the guidance.

This is Tim, Gary. Yes, it was a fact. I only -- that alone did not add a nickel. There were other things that impacted it as well. We had some legal accruals that we were able to reduce, along with the incentive pay, so there was several things that did help, and that was also sort of end of quarter, you know, you don't know. We don't know what the share price is going to be when we close the books, so that's a little hard one to measure, too.

Am I right in my math? You previously thought the corporate admin will be up 5 to 6%, now you see it down 2 to 4%. My math would say that adds about $0.05 to full-year estimates. Is that right?

Well, I didn't do the math but whatever it works out to be. I mean, again, that was a change, and I just haven't done an EPS on it.

How much did it help your third quarter?

I don't have the exact number. As I say, in front of me. We have to get back to you on that, but I know you know what the guidance was and you know what it came in at so that's the difference.

Thank you.

Thank you. Your next question comes from Ann Duignan of Bear Stearns.

Question for Tim or Don. Building off of the questions earlier on forecasting and the lack of clarity on the forecasting process. Have you considered at all internally changing to a calendar reporting period, number one?

Well --

Two, have you made any changes or can you give us any assurance that, you know, your ability to forecast fiscal '06, will you have any better ability to forecast with any degree of accuracy, and will we be asking the same questions at the end of the next quarter, as we look out to fiscal '06? I guess what I'm getting at is there appears, from the outside that there may be something broken with your forecasting process, particularly in Climate and Industrial Controls.

Ann this is Don.

Yeah.

As far as next year, we are considering going to an annual forecast. I'm going to be discussing that with the Board, at an upcoming board meeting. This has been a, you know, a somewhat of a tough situation for us going through here this year, because starting in the second quarter, as Tim indicated earlier, you know, we thought we had a great quarter, and we suffered for hitting would we thought was our number we didn't hit the Street's number. So I came away from that saying, well, maybe my range really doesn't matter a whole lot, because my guidance really doesn't matter as long as the Street is somewhere other than what I've announced, you know, mine doesn't make any difference.

So then we go into the third quarter and it will be interesting to see what happens here, but the concern was that the Street was, you know, up on the high end of our range, and our range was $1.10 to $1.30. And as we were looking and projecting out what March was going to look like, and, really, March is a very big part of the third quarter. I think we've indicated that before. We said, well, if we're going to be on the lower end of this range when the Street is on the higher end, we better give them some new guidance to guide them down, because we're going to get beat up again.

As I look internally at our ability to forecast, there's all kinds of dynamics going on here that we don't talk a lot about. We talk about little bits and pieces. There's foreign exchange, inventories going up and down at 250 locations around the earth, there's LIFO reserves there's mix changes, there's acquisitions and integration and restructuring and countless other things in 1200 markets and 115 business units. So as we say, how exact can we get? I'm giving you about the confidence interval I can get, and have any confidence I'm giving you a meaningful range. I really can't see how I can get to a quarterly guidance that is any more accurate that what we're giving you right now. As a matter of fact, the second quarter we thought we were dead on. We weren't.

The third quarter, as it turns out, we're going to be in the lower end of the original range, not the, you know, the preannounced guidance. So we're going to be a little bit over the top end of that. So, I mean, we're fluctuating back and forth trying to figure out how do we please everybody here, and still run the business.

I guess the amount of time that we spend on this, it's an inordinate amount of time for -- I think what we are coming down on, at least my feeling is that, maybe we give an annual range, and we eliminate all this intermural activity quarter by quarter, which tends to cause all kinds of gyrations with you folks, with the Street, with the stock price, and at the end of the day, when we finish this year, it will be interesting to see how close we came. I know we're going to be better when we announced earlier, because originally we said $3.50 a share. I know we will be will over that.

But it will we interesting to see how close we get to the number we told you after the first quarter, and all the gyrations we went on in between, just doesn't seem like it's all worthwhile. So that's a short -- maybe Tim wanted to add something.

I just want to add on to one point, for everybody here, that Don made. Some things you do to yourself, and some things are external events, and I just wanted to talk about LIFO for a second. For us last year, LIFO was a $3 million expense. For the whole fiscal year, pretax. Already to date, LIFO is up to a $13 million expense. Now, that's a $10 million increase pretax. And the way that has ramped up has been really interesting as well, too. It was less than a million the first quarter, a little over 2 million in the second quarter, this year, and right around 10 million in the third quarter.

Now, my CEO across the way was absolutely whacking me over the head about, why can't you get this LIFO thing closer and right? Why can't we predict that? And I said, well, if anyone can tell me what the price of brass and copper and steel are going to be at the end of the quarter we can do it a lot better. But if I had that information, I could also retire by the end of the quarter.

So you all -- everyone knows that these materials have been going up, and, therefore, you know, it's caused a significant rise, but that, in terms of looking at the performance and comparing periods to periods, as I say, $13 million year to date versus 3 million all of last year, and we're not done for that year. We've got a quarter to go. We only had 3 million all year, and it was a $7 million difference this third quarter versus last year. So that's some of the hard parts in doing this.

And thus the question around whether you would consider moving to calendar year forecasting basis, where at least you're struggling with the same unknowns as everybody else, and there tends to be a little more consensus building when you're forecasts in December rather than in July. We appreciate that trying to forecast what's going to happen the first half of the calendar year of the next year when you're sitting in July is pretty darn tough.

Ann, it don't think it ought to help one way or the other whether we start at mid-year or at the beginning of the year or the middle of the year. I think our process is basically a bottoms-up process. When we give you guidance, we have six weeks of backlog and we're projecting out based on a lot of unknowns for the balance of the quarter, and certainly for the year, when we have six weeks of backlog it's really just a forecast for the year because we just don't have the information to be any more exact than that, other than general economic conditions. So changing to a calendar year, in many respects, it probably would be good.

I'm sure there's some down side of doing that, and I don't understand all of the down sides, but I think the -- I think it would allow you to make comparisons maybe easier with industry data and so on and so forth, but I don't think that's been our problem here, not that we have a serious problem, based on the way I'm looking at it. The way the Street looks at it we've got a serious problem. But I don't think that would be the solution. It is something that we certainly have talked about internally but haven't made any decision to do that.

Okay. Just one follow-up business question. Looking at the national power data over the last couple of months, it looks to us like shipments of spare parts has picked up significantly, while OEM shipments have slowed somewhat. Is that what you're seeing out in the business world, and can you give us some color on what you are seeing out there, between OEM demand and aftermarket spare parts in the industrial side?

Well, I think what we're seeing strength, when we're talk about fluid power in particular, primarily hydraulics and connectors, I think we're still seeing a lot of strength on the OEM side certainly, construction and certainly in ag. Maybe ag is in the as strong as it was, but certainly construction is. When we look at our cyclicals there I see there's nothing going south in the construction side of continues. And heavy-duty truck is strong. So I think the OEM side remains strong and will.

Okay. But are you seeing any acceleration on the distribution business?

Well, the distribution has been building all along. You know, the OEM started this recovery and the distribution followed along, and the distribution has been building all along, and, yes, I think we are continuing to grow on the distributor side of our business and our charts would indicate that's the case.

Thank you. I better get back in line. Thanks. Thank you, Ann.

Thank you. Your next question comes from Alex Blanton of Ingalls & Snyder.

Just to comment on what you just said, if you eliminate the quarterly estimate you're going to make things a lot worse, because then the analysts are on their own, they're going to be all over the map, and the chances of missing the guidance are much greater than if you had quarterly guidance. Now, quarterly guidance is a problem. If you come in at the low end of the range, and the analysts at the high end. But nevertheless you're going to make it worse if you eliminate it.

Now, one thing you can do is when you issue your press release, you put the guidance in the first paragraph. That way, when The Wall Street Journal and Reuters and so on pick up the news they're going to read that you had a certain number, and the next sentence says it's within your guidance. You give the guidance that you had before right in the press release, so that the newspapers understand that your number came within your own guidance, no matter what the analysts were erroneously using. And you can do that, and the chances are greater than the press will treat this a little differently than just saying you missed the quarter. If you put the guidance in the first paragraph, and maybe the second sentence of the release. Because, you know, the reporters read about five sentences, then they write their story.

Now, secondly, you had great numbers in the quarter. I'm interested in what's behind the numbers, how you're getting these big increases in gross margin, and you had mentioned earlier in the year in the first quarter that you have long-term supply agreements with both your suppliers and your customers, you're in the middle of the supply chain there, and your suppliers have agreed to deliver everything on time, even if they don't deliver to other people on time, and in return you're taking their cost increases and passing them along, and then from your customers point, you promised to deliver on time, and they agree to take all of the cost increases that you give them, that you can document, so that you're delivering on time, your on-time deliveries are at a record level, you said last quarter, and everything is running very, very smoothly, you aren't suffering any earnings erosion from supply related problems, as other people are. Now, the question is this. In the third quarter, did all of those benefits continue?

I would to have say, this is Don, Alex, I would have to say yes. Nothing has changed throughout the year from that standpoint. I think we've been very disciplined with respect to working with the customers on these -- on the raw material increases, certainly that we've seen. We actually were out working with them earlier than most of our competitors. I think that's what helped us in the early -- I'm talking about a year ago now. We started back in October of the prior year discussing increases. And there's always a lag time that you have from the standpoint of when you incurred increase to when you potentially recover it. So I think what we've been doing is just staying focused on that, working with the customers. We started with surcharges. Some of those surcharges have rolled into price increases now as opposed to surcharges.

The distribution side of our business, as I've said before, has been consistent with the way we've dealt with that. Normally those increases would go in January or June of the year, and they could go more often than that if we had extraordinary increases that we had to pass on, and that's half of our industrial business. So I think our program has not changed one bit. We've been focused on lean and procurement and pricing here have, for the last four or five years, and we continue to get traction there.

So I think when you say what's good happening, I think a lot of the same things that have been happening all along is executing on the win initiatives that we started on, we're getting a lot of traction, we'll never be done, we're going to continue to be working on these forever, and that's really impacting the quarter, as well as the year.

By the way, when I get back to this guidance and talk a little bit about, Alex, your first question, so when we come back here and we talk about the guidance, and what we should do and so on and so forth, I guess the disappointment here is that we're having a -- one of the best years in the history of the Company, by any measure. And everyone around here is feeling bad because of what's happening with respect to this guidance, going back and forth and the Street expectations and what have you. So it's really been demoralizing on the team to be doing so well, and yet to be perceived so bad. So that's part of it.

I think what you said about putting the guidance in the first sentence of our announcements I think is good. However, I've been watching lately very closely what's happening on the Street with other people that have been announcing, and it seems to me that the tendency is pretty much almost 100% now, that if you don't at least hit the -- what the analysts have gone out with, you're not going to like the answer, irrespective of where your range is. if you don't hit what the analysts have set or better, and the analysts, wherever they get their numbers from, they get them, but if you don't hit that number or better, your range really doesn't matter.

It doesn't really -- there's nothing you can do about that. You're going to make it worse if you don't give guidance, because then the analysts are going to be even further off the mark. At least you can keep the analysts close to where you think you're going to be, and maybe you want to underestimate the range, so that if the analysts hit the top end of the range, you'll still hit the number. There's --

But then we'll be criticized for being conservative, as has happened.

Better to be criticized for being conservative than to miss the numbers.

But that's the take, Alex. We don't think we missed the number.

I know.

Second quarter we hit the number right on the nose. If I was any number other than the number I hit I would have probably had more of a deviation from mean that I had. I hit the number right on the nose and I didn't like the -- or the Street didn't like the answer.

Well, --.

I don't know how to teal with that because if the midpoint of my range doesn't mean anything, if the low end of the range doesn't mean anything, and the upper end of the range, if the analysts are way up on the top side doesn't mean anything I'm saying my range probably doesn't mean anything. That's kind of what I'm coming back with. The reality is if the analysts are on the high number, and I'm anywhere other than that irrespective of where it is in the range, where I am with respect to actual compared to my range, I lose.

Yeah, but --.

I don't mean I lose. I'm just saying that we don't like the result we get on the Street.

If you don't give quarterly guidance you will make it worse.

Well, I've been watching --.

you can -- you can get the media to mention your range if you put it in the first paragraph, and that should mitigate the problem, in some cases it does. I mean, I've seen cases where the earnings miss the analyst forecast, but came in the range and the stock was fine. What happened to your stock was a travesty, and totally unwarranted, and now we have a very cheap stock. But you just can't do anything about this stuff. It's the way it is.

I have a follow-up on my other question, and that is, I was -- understand that you're delivering on time to some customers who are not getting deliveries on time from other suppliers, so they're telling you to hold off on delivery because they can't assemble the product even if they had your product, because somebody else is late. So there's some inventory sitting there waiting to be delivered when the customer says he's ready for it. Is that the case now, and how much is it?

Well, I think, Alex, the only market in particular that I would say that that's happened to, to any great extent, had been the truck market, heavy-duty truck, because there were shortages of some items, some of the larger items that go on the truck, and, of course, they don't need our parts if they can't move those trucks down the production line. So I think there had been some there.

Our service levels are at an all-time high overall, okay, I'm just saying overall. That's not to say we don't have spotty challenges in certain areas, but overall as a result of our win initiatives, and specifically lean in the way we've organized our factories, and I see this every month, I get a report which lists every division in the corporation and what their service level is this month, last month, the last 12 months, last year, the previous year, and so forth, and I can tell you we're at very, very high levels. You're never good enough, but we're at very high levels. We're not losing business because we can't deliver. Hopefully we're gaining business because we can deliver and others can't.

Okay. Great. Thank you very much.

Thank you, Alex.

Thank you. Your next question comes from Ned Armstrong of FBR.

In your press release you alluded to benefits from both the Sporlan and Acadia acquisitions. Was that more from the absence of integration costs or were there benefits from entering new markets, or cross-selling, cost-saving type of benefits? Could you elaborate on where those benefits came from?

I was just mentioning those because they were the largest ones, to be quite honest. I just was mentioning those because they absolutely -- in Sporlan, you can see in the CIC results what's happening with that.

Right. But I guess what I'm getting at, is that purely just from having Sporlan, or have there been incremental benefits from having Sporlan combined with Parker taking to you a higher level?

There obviously are some incremental benefits. When you look at the Win Strategy, immediately when we took on Sporlan, from a procurement standpoint there were some savings we were able to realize right away because we were able to put them in -- you know, put them on our program.

Okay. And the situation was the same with Acadia, as well, I would presume?

Yes.

Thanks very much.

thank you.

Thank you. Your next question comes from David Bleustein of UBS.

Good morning, still. There's been a great deal of uncertainty about -- or variability, if you will, around your incremental margins. Can you just talk through what you would expect your incremental margins to look like over the next 12 to 18 months? What's normal?

David, this is Tim. If we could, we have told you, again, within the Win Strategy, you know, we are looking for that 30% marginal return, and we measure that on the external numbers here. We measure that at the, you know, the segment operating income line, and year-to-date, you know, we're right at 30% year-to-date. So that's how we -- that's how we measure it, and it was -- now, it's a little challenging.

The third quarter was only down around 24, 25%, and why was that? It wasn't -- the base businesses delivered the 30, but you have these couple of big acquisitions, Acadia and Sporlan, and obviously they didn't come in making 30% margin so that pulls the average down. But year-to-date, if you look at the year-to-date, and you will see that at 30%, so that is what we manage to, try to and that's what we're going to continue to try to do. It gets, you know, earlier days, in a recovery you can do higher than that. Later days, it gets tough to maintain it, but that's our target.

My related follow-up is really on input costs. With hot rolled band prices in 20% plus from the peak, when do you expect to be talking about the impact of lower input costs in your financials, and when would that run through your LIFO calculation, if at all?

Well, the way, it would run right away. The problem with LIFO always has been for us, and this has been relatively benign, as you know, for a lot of years. It's only in this last year or so that we've seen some of this inflation run way up on us. But what happens on the LIFO, and that's what makes it tough, you have to wait until the end of the quarter, then work backwards. Okay? You can't be building up the data from the first day of the quarter. You start with the last day of the quarter, and you kind of work backwards. Because the last in, is what went out first. What that means, David, it's a mark-to-market, almost, at the end of the quarter.

And if they have gone down, this number that I've given you, this 13 million to-date, I don't know what's going to happen in the fourth quarter, you know, we could pick up another 3 or 4 million, or if they're all down, we could reverse out 3 or 4 million, you know, just to throw numbers out. But it would be an immediate impact in that regard.

What is the lag between the time we see hot rolled band prices peak, according to American metal market, and the time when you would start to see them rolling through your cost -- your income statement?

David, the one comment I would like to make on the steel side is that hot rolled sheet really doesn't affect us at all, those prices. Our raw material with respect to steel, is primarily bar stock, 12 L 14 leaded bar stock, and in addition to, of course, that's -- as far as the steel side. We also have high -- some divisions and some groups would be high in stainless steel, others would be high in copper, brass, and aluminum.

I would say that on the steel side we have not seen the decreases as of yet, We have seen not roll come down first. I would say that on the steel side we have not seen the decreases as of yet. We've seen hot roll come down first. The expectation would be that these would start dropping right behind. We haven't seen that yet.

In fact, in some of these other commodities we see them continue to go up. The copper, brass, aluminum, stainless, and so forth. If oil prices stay up I think that's going to impact probably the, you know, some of the other synthetic polymers that we deal with, the rubber polymers and thermal plastics and what have you. So we're not seeing that necessarily at this point.

All right. And can you talk just final question, on your pricing, are you at this point pricing through the entirety of your input cost increases? Where do you see yourself on the cost versus price continuum?

We think we're pretty much in line as I said before earlier that we think we've got an earlier start at it, the majority had been passed on through certainly very promptly through to distribution. That's half of the industrial business.

The OEM side, of course, you're constantly negotiating there. We had a lot of push-back as we always do, and I think the reality came down to that the OEMs finally got to the point where they said, hey, we've got to have parts, and they were starting to see shortages, and we said, hey, we've got parts but we need to make sure that we can get a return and order the next load of raw materials here. So we were able to do surcharges which later turned, in some cases, into increases so we could try to achieve pretty much parity. Are we 100%? Probably not but we're pretty close to parity between the cost increases that we incurred, and the price increases that we've been able to get.

And I think, again, the concern on the customer's side was just getting parts. I think they finally realized that hey, it doesn't do any good, you know, to beat you up on the pricing when they can't get parts anywhere. They want to do business with somebody who can deliver, and I think that was Alex's point that he made earlier.

Terrific. Thanks.

Thank you. Your next question comes from Andy Casey of Prudential.

Hi, Pam, and hi, everybody else. Just a couple of detail questions. The 6 million in realignment expense, 4 million for your prior press release was in Germany. Where did the other 2 fall, just in terms of segments?

There was -- 4 million of the realignment is Germany. It is a -- it's sort of the after effects of the Denison acquisition, this is something that we finally decided to do. The other 2 million occurred in France. It has to do with a -- it's not a realignment per se, but it's an arrangement we have in terms of exiting a facility there, and it's -- we've done this one other time. It works out quite well.

We found somebody who will take over the facility and the workers so we can avoid some redundancy payments. At first they produce the stuff we still want from there, and then they shift over to what they want to produce, and we move our stuff somewhere else, so it's kind of a -- but there's a couple million. So that was in Europe. That's industrial as well.

Okay. Thanks. Then in your European industrial commentary, I think Pam went through this, you mentioned agriculture equipment makes up a big chunk of the demand profile. Have you seen any improvement there in the ag equipment sector?

Yeah, that's where we're seeing -- I mean, in Europe what we are seeing, Andy, is the classic, you know, just like here in North America, you know, if we replay this thing, it began in the mobile side, then it kind of spread into the general industrial, then we get the distributor coming along. We're seeing the mobile people over there be the best. Okay, those are the best markets for us right now. So that's ag and construction and mining and all of those.

Okay. Then the last question, you know, typically you see good cash flow coming in, in your fourth fiscal, and you've indicated that the priority for cash is growth prospects through acquisition. What are you seeing right now? Some other companies through their actions recently have indicated there might not be any significant ones in the near term. Are you seeing pipeline still full, or is pricing kind of precluding near-term stuff?

Andy, we're still -- we still have a lot of activity going on, and we're looking at a lot of different opportunities.

Pricing tends to be in line with what the value of the Company is on a discounted cash flow basis. I don't think there's anything unusual going on there. As you know, our goal is 10%, what we're trying to grow over, you know, a five-year compound growth rate average. We're down lower than that through the recession, so we want to do better than that in the good times, and we're on target here to hopefully do that.

So you're right, we do want to deploy the free cash flow into building the business, and we think we've been doing that successfully over time and we want to continue that.

Thank you.

Thank you. Your next question comes from Joel Tiss from Lehman Brothers.

Thank you very much for all the information. I think this is great. One, maybe like two big picture questions. One, if you can just talk about if the lumpiness of your business has changed, or is it just where we are in the cycle, and then second, you know, talk about the longer term goal of 15% operating margins, and if those are within sight, say in the next 12 to 18 months or so. So thank you.

Okay, Joe. This is Tim. Let me try the first part, then I will let Don table the tougher one there, on the 15%. No, I would say things have not changed at all. Having been around here for a long time, as a lot of us have been, this looks pretty classic in terms of a recovery and the expansion, and generally we do -- in sort of a normal environment we'll do a 48/52 split on our revenues from first half, second half. And that's driven just sheer on workdays, okay, just -- we get all that stuff in the first half, the extra holidays and vacations and so, typically 48/52.

Now, depending if we're kind of an up or down, but I think we're kind of in that 48/52 mode, and as I say, I think there's a classic way these markets come back and perform, and I think what we're -- where we are right now, kind of year and a half into this recovery, is we're just now starting to see people feel good enough. They used up their excess capacity, and I think we're just beginning to see people now interested in spending some capital money. I can see this a little bit internally to Parker. We just looked in the mirror sometimes. But also you can see it out there in the customer base, too. And that is typical to it.

The expansion continues. All of a sudden people do loosen up the purse strings, and they now need the CapEx, and that should help us, you know, carry this for couple more years. That would be how it would usually unfold. So I'd say it's -- I don't think we've seen any big changes.

The 15% I'm going to give to Don to talk.

Just a couple comments on the 15.

The real objective in the Company is to get the performance of the Company into the top quartile compared to our peer group, that we would compare ourselves to, as far as return on invested capital. That's our #1 objective, to be in that top quartile of our peers with respect to return on invested capital. We were able to do that in fiscal '04, we were in the top quartile. That's our #1 objective. We don't need 15% to get there. What we're trying to do overall as a Company is deliver 4 points of EVA.

We don't need 15% to deliver 4 points of EVA, but we've set that as target because we know that if we do hit the 15% by unit, that we will be definitely delivering 4 points, if not more, of EVA. It's really a function, internally here, of how well we do executing on the Win initiatives. We've been talking about those a lot. The purchasing, the lean, and the pricing and we're seeing a lot of very, very positive impact from executing there, and that's going to be ongoing. It's not done yet.

I think what we've said is that we're trying to deliver 6 points, 2, 2, and 2 from the three major initiatives of purchasing, pricing, and lean over a period of years. We know we're going to be over 5% overall, cumulative at the end of fiscal '05, and we will see what happens in '06. We will be forecasting that next. So there's a lot more to go on there.

On the negative side what it does effect, achieving the 15%, is, you know, the margin that you bring in on your acquisitions, because we are growing significantly based on acquisitions, and how fast you can integrate those acquisitions and get those margins back up, if they need to be brought up. Some of our acquisitions don't need to be brought up, but how fast you can integrate, and we've established internally here a very fast integration protocol which we're -- we've executed now on all of the more recent acquisitions, and it's working out very well.

And I think a lot of the ramp-up you've seen here and been surprised of since we made some of the big acquisitions is a result of the fact that we've been able to integrate very quickly, get the major savings underway and get the major restructuring done quickly, so that we can move forward from there and build those margins.

So our goal is still 15, but keep in mind our #1objective overall is to be in the top quartile as far as return on invested capital. We're competing with those top companies for investor capital. We think that being in the top quartile on our returns, drives the investment capital to Parker long term, and that's the reason for it.

Okay. Thank you very much.

Thanks, Joel.

Thank you. Your next question comes from Barry Bannister of Legg Mason.

Just an observation first. Just seems to me that what's happened over time is that Parker has become more of a short lead time minimal backlog company serving customers with just-in-time preferences. So maybe that's just made the Company more sensitive to the monthly news flow on ISM and IP and made investors more jumpy, and also not having a backlog probably makes you a little harder to predict your quarterly earnings, don't you think?

Well, as our ability to -- I think you're right. I think as our ability to service continues to improve, I think what happens is that certainly our OEMs who want to hold absolutely no inventory take advantage of that, so their lead times to us go down, and I think our distribution certainly sees that as we deliver faster and faster and more predictably that the amount that they have to hold in inventory goes down, so I think that yeah, the whole cycle -- and I don't know that it's just unique to Parker, but I think as a result of this whole lean effort going on, certainly within our Company, our ability to service the customer is going up greatly and certainly our OEM customers, and our distribution has taken advantage of that.

The good news, Don, as inflation goes up, just-in-time goes out the window, so maybe that will help you in the future.

[LAUGHTER] Right.

Let me ask a question on defense Aerospace. My understanding in the past was that the original equipment side of defense/Aero was the stronger margin, because these are small runs of very expensive products to develop, where as in commercial obviously aftermarket is the most profitable. First of all is that true?

Second, has the Pentagon slowed down, because of budget problems, some purchases of systems that may have affected you on the margins on the OE side of defense?

This is Tim Pistell. Let me take that one on, if we can array the margins in Aerospace, and starting on the left, when you have the commercial OE, you always start in the hole. You start in the red, you hope you kind of eventually get to a breakeven on the commercial OE. Okay?

Now, on the military OE, they do allow you to make a little money on that but not a lot. I mean, but, because a lot of the programs aren't guaranteed to go forward, get through Congress. So we are allowed to make a little bit, but pretty small margins, pretty slim margins on the military OE.

Then if you keep moving to the right in the aftermarket, the military aftermarket because you know all the issues with $600 hammers and all that sort of thing, and they're letting you make some money on -- you make a higher margin in the aftermarket but you don't make, you know, as high as you do, and the one in the far would be the commercial.

And in the commercial that's how the ball game is played. It's all -- you understand this. You do your best to breakeven originally, and then you're going to make your margin in the aftermarket. So kind of that's the array that occurs there.

Any budget pressures affecting commercial because you hear the defense talking about pushing out some programs?

well, interestingly, it just depends on the programs and where you are. Right now, for instance, the -- we're doing quite well in helicopters, as you might imagine, with what's gone on. The F-22 we know has had some setbacks. There was an odd planes. The joint Strike Fighter I think we're still pretty much on target. There's not much going on there, except for the nonrecurring engineering.

What is making up for some of the other areas is the Unmanned Aircraft Vehicles. There is a huge amount of excitement in Congress over these programs, and they're beefing the funding up considerably on the UAVs, and, so you know, there's some pluses and some minuses. Collectively, it's -- there's no problem there. I mean, it's pretty solid.

Thanks.

Thank you.

Thank you. Your next question comes from Jeff Hammond of Keybanc Capital Markets.

Good morning.

Good morning, Jeff.

If you look at the segment guidance, specifically North American Industrial and Industrial rest of world, this quarter versus your last quarter's presentation, looks like you're coming in 45 basis points lower for North America Industrial, 30 basis points lower Industrial rest of world. Just want to understand what's changed there, how much is it mix versus maybe some raw material contracts, versus maybe just a little bit -- too much optimism? Maybe just a little more color there?

Yes, Jeff, I'll answer that. You know, I think in some respects you guys try to shave this down to a whisker. We kind of look at where we want to be.

We kind of look at where we want to be and we work with our model just as you guys do, so I don't think you can take any one segment, and draw any main conclusions from that. I think if you look at the previous guidance versus the guidance this time you will see the major difference is in rest of world. On the sales line, we went up.

As you recall in the last conference call, we spent some time talking about this and I think, you know, at the end of the day concluded that yeah, maybe we were a little bit conservative on that, and based on where we're at on a year-to-date basis and based on what I talked about with respect to the markets in some of the countries, that in Europe it's probably going to be a little bit better. So, you know, in terms of guidance to guidance I think you see the sales coming up a little bit.

In terms of the margins, there's a slight difference but again I think, you know, getting past that minutia and getting to the big picture, what's happening is we have taken it up on an operating margin a little bit, offset by increased in taxes. You know, the guidance is just that, to give some type of guidance but not get down to the penny.

Maybe ask it a different way. If you can maybe address raw material costs sequentially over the last couple of quarters, your actual input costs, given how contracts are rolling on and off, relative to what we're seeing in the macro data, and what was discussed before as far as steel costs coming down.

Well, I think, you know, Don talked about the costs. I think from an input side, like I said, I think we're -- you know, steel costs are still there. It's still something we're -- aluminum, brass, and copper continue to increase. That's not changing any. They continue -- they're on an upward slope affecting some of our businesses. From a steel perspective I think that it's peaked.

Okay. Thank you.

Thanks, Jeff. Next?

Your next question comes from John McGinty of CSFB.

Hi, John. John?

Sorry. Hello. Sorry. Can you hear me now?

Yes.

Sorry about that. Tim, just a quick follow-up. Where does the LIFO show up? Is it in the different divisions, or do you take it -- I assume that's where it is. I just want to make sure I understood that.

No, we take it at corporate, John, because it was a tax thing that a lot of people put in way back in the '70s with the hyper-inflation, so they did it at corporate. So the divisions work on a FIFO basis, and we back all the LIFO reserve here. So they report their indices on materials, labors, overhead, we compute it here.

The other question, if I could ask, I don't think I'll get an answer, but let me ask it, on price. In other words, Pam, you took acquisitions in currency out so you got a 5% kind of underlying core growth in the quarter. Could you -- could you make a guess at how much of that is price, I know that's very difficult, but, on the other hand you should be measuring it, I assume, under the Win Strategy. Is it 1, 2%, or what do you think?

2%. Maybe.

Just as a follow-up, Jack made a comment last quarter which said incremental margins were so strong in the first quarter in North American Industrial, then diminished in the second, was that you had been very aggressive and been out in front raising the prices very early on, because you saw costs coming, and that you didn't in the second quarter.

Is that still a factor? In other words, if we look at prices, are they going up as you look at the Win Strategy, across the board every quarter, or do they tend more to be front-loaded, as Jack had said, or was that an unusual event?

John, this is Tim. We tend to in Parker-Hannifin we try to schedule price increases, for distributor price lists and other, we try to do it January 1 and July 1, okay.

Right.

So -- because we have a lot of divisions selling the same customers. And so those are the big changes, July 1. So what Jack was saying was true. We had an opportunity on the July 1 increases, seeing what was happening, to go out there fairly strong, be the price leader, you know, we -- Parker prides itself really on being the price leader.

We're going to beat other people with, you know, with innovation and delivery and quality and so you're going to pay the -- you may pay the highest price, but so be it, you'll get the best of the rest. So we were fairly aggressive and we probably did get out ahead in the second quarter, that probably the cost increases caught up to us, and that had some of the impact, but now we had -- we have another opportunity January 1 and, you know, and so that's how we normally do it. Now, those are on the distributor-type items, okay.

Right.

On the -- obviously the major OEs, they're all on contracts, and, you know, they renew all over the course of the year.

With no mean nor mode as to when most of them happen? It literally is just kind of spread out randomly? Not randomly, but evenly?

Yeah, we're talking to them. There always seems like every month we have a few big contracts coming up that we're working on, and that's still a very, very tough environment. Those are tough hombres to negotiate with.

Final question. Are we at a point -- it was not clear -- this was a comment that was made back at the end of March on the pre-announcement -- are we at a point right now where we are suffering from reducing inventory, where we were un, usually building it earlier or is that just the normal seasonal we're talking about?

One comment to your comment about pricing, I wouldn't want you to overlook the fact that our inventory was up in that first quarter, and obviously when the inventory is up, you have a positive impact on your operating performance. I think it was up $50-some million, and likewise, in the last quarter, it was down almost $30 million, and obviously you get the impact of the LIFO in that direction, as well as the impact of the lower absorption from net reduction. So don't underestimate the size and magnitude of this, and one of the reasons why I pointed that out earlier was the fact that I don't know what that number is. We're all driving -- the entire organization is being driven in this lean environment, driven toward the same goals, as far as inventory reduction.

We've got the inventory down now. I stated that four years ago, that I was -- with it was at 18 or 19%, or $0.18 or $0.19 per dollar of sale, I wanted to get it down to 12. That would be best-in-class. And we're down at around 13 now. It's not going to be a straight line. There's going to be ups and downs depending on the dynamics, what's going object. We had some prebuys in some cases on some raw materials in certain areas and so forth, but the general trend is going to be down at least until we get to the $0.12 level, then we'll recalibrate from there, depending -- I think some divisions will have more work to do than others. We'll see how much more we want to do.

I think what's happening we're seeing that we're still delivering at very high levels, actually higher levels now with lower inventory levels, than we've ever delivered before. Our customer service is at all-time highs in most cases. We like what's happening. We like the effect of the lean. I don't like the fact that I can't forecast this to the penny, because we do get big gyrations here which do impact the operating performance.

Great. Thank you very much.

Thank you, John. Can we take just a couple more questions here. It's well over the hour, and two more would be good.

Thank you. Your next question comes from Yvonne Varano of Jefferies.

Thank you. Could you break down that 5% improvement in margin that you talked about between the procurement, the pricing, and the lean?

No. I can't because it's not a GAAP thing we talked about that internally here. I just can't tell you numbers that aren't exactly per GAAP. I do share -- internally in the Company we do share numbers, our best estimates as far as the split between those three, but I can't really go public on breaking those down any further.

Okay. In the north American industrial, can you just talk a little bit about how the business trended sequentially through the quarter, on a monthly basis? It seems -- I know March is usually your strongest quarter, but just trying to see if we're going to continue to see that strength going into April and going forward.

Yeah, I think -- and I'll let Pam add on to this -- but I think what we would be telling you, we don't see any change between third and fourth. We think that the activity levels are going to remain. Hopefully there won't be any surprises there. I think that at least at this point we don't see any major -- any reason to indicate the next quarter is going to be worse than this quarter, or any different from an activity standpoint.

Right. Okay. I know this issue has been beaten a bit, but when I look at what you put out, the expectations for fourth quarter, you have a low end range of $1.04, and a high end of $1.24, and if you think 4Q is going to be better than 3Q, should I take away from that that you're expecting earnings at the higher end of the range with 3Q coming in at $1.18? I'm just trying to see how I should be reading what you're telling us.

Hi, Yvonne this is Tim. Let me make this real simple. What we said is we just had a great third quarter, and we're expecting to pretty much repeat it in the fourth quarter. With a couple little tweaks here. Tax rate may be a little higher, couple of the segments have to perform a little better, but we hope to have a repeat in the fourth quarter of the third.

I just want to -- I'm glad -- go back on this a little bit, because I do want to say on this, we started the year at, you know, a midpoint range of $3.50. That clearly was too conservative based upon the expansion finally was really here and it kept ramping up, a and so we had a dynamite first quarter. And we were too conservative, obviously, we came out adjusting that to $4.50. When we did that, there was no conservative left in that. That was very aggressive, that was the best we could do, but there was no conservatism left. When we did that. Now, what happened since we did the $4.50?

Well, the next quarter we gave a midpoint of $0.95, we delivered $0.94, and the Street was up there at $1.03, $1.04, and we got whacked. We were within a penny, which we thought was pretty (expletive) good, but we got whacked. We suffered through that, the next quarter we get a midpoint out there at $1.20, and again, maybe we were too exuberant that nothing was going to go wrong, but -- and what happened, the Street is already moving up again. They're at $1.24 and they're moving up.

Tim now I'm listening to you tell me you have a midpoint of $1.14, yet your comments suggest it's going to be higher than that.

What we've said Yvonne, we had a very strong third quarter at the end of the day. Again, we didn't get to the $1.20, and we had to readjust and everything else, but, you know, without the nonrecurring we did $1.14. We think we'll have a strong fourth quarter and it will be around the same number. Some of the segments will be a little higher. The rate will be a little less. And that's it.

I mean, again, in terms of the range and what you want to do, it seems, like Don said earlier, no matter what we put out there, you know, it seems like everyone adds a nickel or a dime to it sometimes, and away we go. But that's the best. If we think -- if we end up doing as good in the fourth quarter, we just did in the third, it's going to be very, very good year all the way around.

Yeah. And I just want to reiterate, I said slightly better. When I said slightly, I meant very slightly. So, you know, I just want to clarify, because I did say that, and I want to make sure that people understand what I meant when I said that.

That slightly suggests $1.18 to $1.24?

No. You and I have --.

I'll call you.

We'll have a conversation about that. But I think -- what I want you to go away with, is what Tim just said. You know, we're looking at fourth quarter to be very similar to third quarter. The components have changed a little bit, obviously because of the tax situation, but that's where we pretty much stand right now. Okay?

Okay.

One more question.

Thank you. Your final question comes from Wendy Caplan of Wachovia Securities.

Hi, Wendy.

Hi, good morning. Just -- one of the most common concerns that we're hearing about today is slowing of core growth, and just look back and saw that you know, your core was up 17% in Q1, up 12 in Q2, up 5 in Q3. Given what you've been saying relative to your fourth quarter expectations, do you expect that it will stay in that kind of 5%, mid single-digit range through the balance of the year?

Yeah, Wendy, let me answer that. That's a very good question, and I think it's a relevant one. If you go back and look at last year where we were, we didn't have any growth in the first half of the year, and all our growth came in the second half of the year. So, you know, it's not unusual that you would see those increment -- you would see that type of sales growth falling off.

If you look at our orders, we're coming up against some really tough, tough comparables. North America alone has 30% in May. So the growth is not a concern. I want to reiterate what I said earlier. Orders are very good, our backlog is very good. There isn't anything that suggests that things are different at this point in time. So what you're seeing is just a result of the high incrementals, and we're not concerned by that. Does that answer your question?

Thank you.

Thank you.

Okay. I guess that was the last question. I just would like to maybe make a couple comments at the end here, before Pam closes it out. First of all, I thought it was a good discussion. We took a little bit longer than what we normally would take, but I think we needed to get all these issues out on the table, and discuss them in a little bit more detail, just a recap, though.

As I look at what happened here in the third quarter, I see some very, very good things happening at the Company. It's our first $2 billion quarter. We didn't mention that at all, but it really was our first $2 billion quarter. Sales for the quarter were up 14%, which is very strong, operating income up 34%. A lot of good things happening internally in the Company. We mentioned cash flow. If we continue at this pace we'll have another record cash flow for the Company. The DSI was down 6 days from last year. The DSO down 3 days, productivity was up 7%, we're driving productivity with the Win initiatives all throughout the entire corporation. Orders in backlog are at an all-time high level. So we're very excited and very pleased with the results of the quarter.

When we look at the year, as to what we think is going to happen here to the balance of the year, it's going to be our first $8 billion. We spent one year in the 7s, and we should be out of the7s into, the 8s, so we'll be exceeding $8 billion for the year, up about somewhere around 15%. Our net income should be up about 50%, which is spectacular, we think, it's going to be an all-time record cash flow, like I said, if we continue on the pace that we're going right now, that should be an all-time record, and the balance sheet is in great shape. A year and a half ago when I looked at the balance sheet I couldn't buy anything.

The balance sheet, you know, we were already at the top of our leverage range. And we didn't want to jeopardize our ratings but now we're in great shape and we can do some things here, and we're certainly looking at a lot of things internally, so I'm really hoping that the Street goes away feeling good about the Company, and about what we've done and where we're headed from here.

So I will turn it over to Pam for the close-out.

Yes, I would like thank that you for your participation today, and I thank you for all the questions, and like Don said, I do apologize for going, you know, having such a lengthy conference. Hopefully it was helpful, and I look forward to talking to all of you. Good-bye.

Thank you. This concludes today's conference call. You may now disconnect.