派克漢尼汾 (PH) 2005 Q4 法說會逐字稿

At this time I would like to welcome everyone to the Parker Hannifin fourth-quarter 2005 earnings release conference call. (OPERATOR INSTRUCTIONS). Ms. Huggins, you may begin your conference.

This is Pam Huggins speaking. Good morning to all of you, and welcome to Parker Hannifin's fourth-quarter teleconference. As usual, I will begin with a couple of housekeeping items today. The webcast of the teleconference and the slides that we will be using as usual will remain on Parker's Website at phstock.com of course until the next earnings release. Also, as a reminder, please remember when we get to the Q&A session, please limit your questions to one at a time in order to give everyone a chance to participate. The answer session will commence at the end of my prepared remarks as usual.

At this time I would like to call your attention to the disclosure statement on forward looking statements, and ask you to read it in its entirety if you haven't already done so. And again, the numbers that will be presented today are on a GAAP basis with one exception, that exception of course being sales. The sales numbers have been reconciled from a GAAP basis to that without acquisitions and divestitures and currencies to allow for a valid comparison from period to period. As is customary, I won't be reviewing each slide in detail, but we will focus on the highlights only.

With that I'll start with the agenda. The agenda today will follow the same format as the past. First I will begin with a summary of the earnings per share results for the quarter and on a year-to-date basis. I will then address the sales growth for the quarter, and again on a year-to-date basis. I will then have a few comments on the influences to sales, specifically our order trends. That will be followed by comments on earnings and the effects of the Win strategy. Segment results will be summarized briefly for the quarter. And then I'll conclude with a quick overview of the balance sheet and cash flow position. And then of course I will close with the outlook for fiscal year 2006.

I'm pleased to report that after my prepared remarks today, Don Washkewicz, the Chairman and CEO, along with Tim Pistell, the Executive Vice President and Chief Financial Officer, will be joining me for the question and answer session.

Starting with earnings. In line with the press release this morning fourth quarter earnings from continuing operations came in at $1.34, 31% higher than earnings per share for the same quarter a year ago. Earnings per share for the full year from continuing operations are up 61% from $2.82 for fiscal year 2004 to $4.55 this year, a record year for Parker.

As you recall I said the first quarter of last year we increased the guidance by $1.00 to $4.30 to $4.70. The earnings per share $4.55 for this year is not only a record year for Parker, but it is solidly within the guidelines that we provided at that time.

Diluted earnings per share for the year on a GAAP basis came in at $5.02, which includes 57 million or $0.47 per share from discontinued operations. As you recall, discontinued operations are the result of the sale of the Wynn specialty chemical business in the second quarter. The results of this were originally included in the other segment. This reclassification has been laid out for you, and it is included as an appendix to the slides.

As we examine the fiscal year 2005 earnings per share of $5.02, which beat our previously stated guidance of $4.72 to $4.92, there was an improvement in the quality of those earnings. The fiscal year 2005 earnings showed contributions from higher volumes that generated a 47% marginal return on sale, lower other expense, lower interest expense, albeit minor, offset by higher corporate administrative expenses. While the corporate administrative expenses were higher than anticipated due to higher incentive payments for the quarter, they are in line with fiscal year 2004 percent of sales. Operating segment income for the quarter increased 31%, of course with margins moving from 12% to 13%, almost 100 basis point improvement.

Turning to sales for the quarter, we are up 13% in the quarter. And of the 13% sales growth, 5% came from acquisitions, 2% from currency, mainly the euro, and 6% organically. Sales were up 17% for the year, for the first time surpassing $8 billion, coming in at 8.2 billion, again a record year for Parker.

For the quarter positive core sales growth was experienced across all segments of Parker's businesses, with the exception of the other group. And again as you probably recall, the other group consisted of business slated for disposition. At the end of fiscal year 2005 the only remaining business in the other segment is currently being disposed of in fiscal year 2006.

Since the sale of the Astron business hasn't enclosed, we haven't made any announcement ourselves. But we have entered into an agreement to sell Astron. And as I just said, it could close in fiscal year 2006. As a result, Astron has been excluded from the results going forward. And I will talk more about that when I get to the guidance section.

Now back to sales. The 13% sales growth that I previously mentioned for the quarter is of course the result of continued industrial end market strength, the successful integration of recent acquisitions, namely Sporlan in the climate industrial control segment of the business, Acadia in advanced products, which are steel businesses, and of course several smaller ones, along with continued strength in the commercial side of the aerospace business. Strength continues across all regions of Parker's businesses, including Europe.

Moving to orders starting with North America, year-over-year order rates have shown growth for 22 consecutive months. And while comparisons have toughened, orders have remained strong. The order rates have been sustainable, surpassing the tough comparisons of the April, May time frame when they were as high as 30%. Orders are stated as a percentage increase over the prior year without acquisitions and currencies. The 5% growth that you are seeing in June is on top of 24% last year.

Markets that remained strong including heavy-duty trucks, construction, oil and gas, mining, agriculture, power generation, just to name a few of the 1200 markets that Parker serves.

Moving to rest of the world, again orders have improved for 22 consecutive months. The 7% increase that you are seeing is on top of 21% last year. Latin America continues to be weak mainly in the agriculture sector. It is not total -- the weakness isn't across the Latin American sector, it is just in the ag portion of the business. China continues to be strong. And Europe, while weakening according to others, continues to do well for Parker. Specifically, the Scandinavian countries, Germany and the UK, are strong. Italy and Spain, while soft early in the year, continues to show strength. And yet France continues to be weak.

Climate and industrial controls orders tend to be lumpy, as you will know, and orders were down 4% in June, mainly due to the weakness in the automotive sector. Remember however, that this percentage increase is before acquisitions and currency. And helping this segment in the future is the newly acquired Sporlan business which is mainly refrigeration and heavily after market oriented. While automotive is down, air-conditioning and refrigeration, they remain solid.

Aerospace continues to ramp up, reporting a 7% increase in orders, which is on top of 15% last year. Remember that aerospace due to the volatility from month-to-month is reported on a twelve-month rolling average. The strength that you are seeing in aerospace is due to the ramp up of the commercial OEM side of the business. Of course you know with increased orders that Boeing and Airbus have announced most recently.

To focus on net income for a moment, it is up 29% for the quarter. And before discontinued operations, income is up 31%. For the year net income increased 75%, 63% from continuing operations. For the quarter income from operations and industrial North America is 16% higher, and in rest of the world 36% higher. The European initiatives, One Face to the Customer and the Win strategy are helping here.

In aerospace, income from operations for the quarter is 24% higher than last year. And while climate and industrial controls didn't see these types of increases, of course due to our automotive market, earnings for the quarter increased 6%. Increased earnings in the quarter in the different segments are due to the increased volume -- running higher volumes through our facilities, and continued success with the Win strategy. This can be seen on the gross margin lines pushing up over 180 basis points for the year.

The results of the Win strategy continued to be seen as margins increased 70 basic basis points in North America, 190 basis points in rest of world, of course they're quite proud of that, and 140 basis points in aerospace. Speaking of the Win strategy on the inventory front, relating to lean, DSI declined five days over last quarter, and productivity increased 9% for the year, evidence of our lean initiatives at work.

Moving to the segment information now, and I will be brief here. For the fourth quarter core sales increased 5% in North America. Acquisitions added 5%. FX added another 1%, resulting in a total sales growth of 11%. For the full year in North America sales increased 17%. On the 11% sales growth for the quarter our margins improved from 13% to 13.7%, a 70 basis point improvement.

Moving to industrial rest of world, core sales increased 7%. Acquisitions added another 2%, mainly the euro in terms of FX. And the total increase in the sales of 14%. For the year though however sales were up 22%. Margins in rest of world -- they moved from 9.9% to 11.8% for the quarter. Again, a 190 basis point improvement. Aerospace sales increased 11% for the quarter, while margins increased to (technical difficulty) from 13.5% a year ago.

Moving to climate and industrial controls. Core sales decreased 6% again as a result of automotive that but I talked about earlier. However, Sporlan contributed 23% to the business in terms of sales, and FX contributed 2%, of course resulting in a total increase for the quarter of 19%. While income as a percentage of sales declined, segment operating income increased 6% in the quarter.

Moving to the other segments, core sales increased 9%. That is including FX, but operating margins declined from 15.5% to 12% as a result of higher metal costs. For the year, however, margins increased from 6.5% to 12.6%. The other segment reflects the divestiture of Wynn Specialty Chemical in the second quarter, which is now included in discontinued operations. But all in all, the segment operation of 13% was very good for Parker, and we're quite pleased with that for the year.

At this point in time I just want to look to the balance sheet. Parker's balance sheet remained strong. Cash on hand at quarter end was 336 million, with no commercial paper outstanding. Working capital was a source of cash, and generated 36 million in the quarter. Inventory in terms of DSI is down three days. And accounts receivable in terms of DSO is also down two days. CapEx as a percent of sales for the year came in at 2%. Debt in the quarter has been reduced by about 19 million. And we contributed another 80 million to our pension plan.

Adjusted total cash ratio is 22.5%. This compares to 24.9% a year ago. But we continued to have cash flow generating close to 900 million in the year, of course a record reaching 10.6 of sales.

At the last conference call we talked about guidance, as you will recall. And some of you have asked about this. So subsequent to the conference call we took the opportunity to prepare some peer analyst in this area. And additionally we retained a third-party to conduct a perception study.

For those of you that participated and were interviewed with respect to the perception study, I just want to say thank you. We of course are very interested in your view. While we don't have the results of the entire study, we did obtain the comments with respect to guidance in time for this release.

Going forward, based on the results of the peer analysis and the perception study, we will continue to provide guidance that we think provides a greater level of exposure than those we benchmarked against. We will provide orders on a monthly basis, annual guidance, segment annual revenue projections stated as a percentage increase over the prior year, segment annual operating margin projections against stated in terms of basis point improvement year-over-year, below the line projections for corporate administration, interest expense, the other category and tax. Although we won't be providing quarterly EPS guidance, we will provide some information that will give you greater insight to our performance on a quarter to quarter basis. And you'll understand that more when I get to the guidance.

Looking forward to fiscal year 2006, Parker's orders indicate favorable market demand with solid single digit sales growth. With this growth the plan is to further improve margins and deliver a repeat of the solid performance of this year. Strong earnings and cash flows near record levels is expected in fiscal year 2006. At this time I will move to our specific guidance for fiscal year 2006 by segment.

North America industrial is projected to increase 6.5 to 7.2%. Rest of world industrial sales are projected to increase 9.4 to 10.4%. Aerospace sales are expected to increase 6 to 7.8%. Climate industrial controls sales are expected to increase 11.4 to 13%. And other -- the other segment will no longer be a segment with a closing of the Astron business. Of course, which was never announced by Parker, but scheduled to close August 31.

We project that the change in operating margin -- moving to the margins by segment is as follows. North America industrial margin ranging from 13.5 to 14.1%, a 60 basis points; rest of world industrial moving up 11.8 to 12.4%, a 60 basis point improvement; aerospace moving up from 14.3 to 14.7, a 40 basis point improvement; and climate, industrial controls moving from 10.6 to 11.7.

Below the line of what we call below the line items, starting with corporate administration, it will be up 11.5 to 12% versus fiscal year 2005. Interest expense of course with the lower debt projected to be down 14 to 16%. Other expense -- other expense income line down 28 to 30% versus fiscal year 2005. And the tax rate for fiscal year 2006 is projected to be 30%.

Now back when I talked about giving you a little color on the quarter to quarter performance going forward, we expect sales during the year to break down -- sales will be 48% in the first half versus 52% in the second half. And the earnings break down for the first half 44%, and the second half 56%. Please remember that the second quarter for Parker is usually lower than the first quarter by a few pennies. It is usually the weakest quarter of the year. Looking to the second half of the year, the third and fourth quarter, usually the fourth quarter is a little higher than the third quarter.

To summarize, fiscal year 2006 earnings per share is expected to be in the range of $5.00 to $5.40. And please remember that this is before FAS 123R. Once you take the $0.15 to $0.20 out that is projected for FAS 123R, it obviously lowers the number to 485 to 525.

Now to summarize briefly, sales increased 12.5% in the quarter, and 17% for the full year. Earnings per share from continuing operations increased 61% versus a year ago. Cash flows is an all-time record and continues to be good, obviously providing the capabilities for us to grow through acquisitions and organically. The focus on the Win strategy continues with inventory reduction, DSI coming down three days, productivity improvement of 9% over the prior year, increased gross margin of 180 basis points, and looking forward orders remain solid. So at this time we are open to any questions that you might have.

(OPERATOR INSTRUCTIONS). Ann Duignan of Bear Stearns.

Great quarter you guys. I guess the question that is foremost in investors' mines going forward is, do you foresee any change to your dividend yield or your share of purchase policy, given the strong cash flows that you have and the low debt to capital? By our estimate you have about -- you have well over $1 billion worth of capacity both for acquisitions and to take up the dividend a little bit. What are you guys thinking about for both dividends and share repurchases going forward?

This is Don Washkewicz. Basically what our goal is on dividends, as you probably are aware, it is 25%. That is a five-year average. We are trending down near that now. I think we're about 26% on dividend if you look at a five-year average. So we're getting into that -- to that point where we're going to be discussing that further, certainly in our finance committee coming up. And we will be addressing if we want to make any changes in the dividend we will doing it at that time.

As far as share repurchases, we're not anticipating that right now. What we plan to do is to execute on our strategy. We think that the strategy is working. We have now been able to demonstrate that we're driving our returns into the top tier of the diversified industrials, and that is exactly what we think really drives -- or maximizes shareholder value.

What we cannot comment on it is what is going on -- what is in the pipeline as far as acquisitions. I just comment that there are things there that we're working on actively in the way of acquisitions. We just won't go into any specifics. But we are very focused on our goal of growing 10%. As you know our growth grossed (ph) 10, and it is 5 from internal and 5 from acquisitions. And there's plenty of activity going on on the second half of that goal. So hopefully that answers that question.

Just as a follow-up, when does this committee meet, and when would we expect to hear anything different on the dividend policy or anything changed?

If we -- well, go ahead.

This is Tim. The committee is scheduled to meet again in August, about mid August. That is always on -- an agenda item. One that we look at and review and determine if we feel we have to do anything or not. So that is when the next time we would look at it.

The other thing I just wanted to clarify on the share repurchase. We do have a share repurchase program that is -- has been approved by the Board. It has been active. And in point of fact you may have noted that over this last quarter alone we reduced the average shares outstanding -- the average for the year -- we reduced it by around 300,000 shares. We have been methodically executing on that. And again our view that the shares were -- have been under valued and so we have been more aggressive of late then earlier.

Just as a final follow-up then. Should we expect no share creep then from options for '06? How should we look at forecasting the share count for '06?

The program we have set up is meant to try to prevent the share creep. It is hard to keep it in balance because we can never quite predict when our employees are going to go see it as an opportunity to exercise a bunch of options. But the intent of the program is to be purchasing in our shares to prevent the creep. So hopefully we'll get it fairly close.

Okay. Thanks. I will follow-up with some other details off-line or get back in queue. Thanks.

Jeff Hammond with KeyBanc Capital Markets.

I guess I wanted to -- just a quick verification on the operating margins. This is a range that you're looking for next year for each other segments?

Yes.

So it looks like I guess on the aerospace side margins flat to slightly down. I just wanted to understand what are kind of the moving pieces within that. I would've expected that to move higher I guess given a better commercial mix going forward?

That's a good question. I can take that. What you are seeing there, we have been talking about it for some time, but what is happening there is while aerospace is ramping up, as you well know, with the Paris Air Show and it was very successful and there were a lot of announcements. And quite frankly, it is all very good for Parker because we did win a lot of new programs. We are actually already in the production stage on some of those.

However, the mix of the business is somewhat of a challenge for us. As you know, the commercial OEM side of the business is the property business, and that is the side of the business that carries lower margins. So when you look at the business there is about 50% that is defense and 50% that is commercial. And it is the commercial side of the business that is ramping up, with the defense side really pretty flat.

So again, like I say, it is kind of a bad news/good news situation. It is good news we won a lot of programs. The bad news the mix of the business is changing right now as a result of programs and the commercial side, which is the higher -- lower margin business ramping up while the higher margin business is relatively stable.

Can you clarify how you are incorporating foreign currency translation into these sales changes for next year? And what assumptions are you using? And maybe a quick comment on pension assumptions expense within the guidance.

Okay. I think for the most part when you look at the currency side of it, and I will let Tim address it he wants to. But from a currency side we don't try to really forecast currency. We forecast using the current rate. And basically since we source locally, manufacture locally and sale locally it really nets on the margin line. So if there's a changing in currency then there will be a change in terms of sales. But really from -- that is the only change that you're really going to see for the most part. We don't try to forecast it, because when you try to forecast it chances are you're probably wrong.

The second question that you asked with respect to pension, we do have higher pension, what we call pension insurance and medical baked into the plan to the tune of about 40 million.

Jeff, Tim, just again we had -- we had some very strong performance on our pension assets this year. But we had -- once again we were lowering some of our assumptions. In particular the discount rate we lowered fairly significantly. And in light of all these -- where these rates are -- have stayed down and so forth, we have had to lower that. So that is forcing some of that change. I think we all know that eventually one day those rates are going to turn around, and they will probably be a plus to us all, but right now -- good performance on the assets, not adding to the liability. It is just really changes in assumptions that created that 40 million.

Stephen Volkmann of Morgan Stanley.

My question is on Europe. Obviously super performance in Europe there. I'm a little interested I guess in maybe you could break down a little bit how you got the margin improvement that you did, you know, price versus moving stuff east versus mix? Whatever color you could give us there would be great.

And then the micro data that I can see in Europe seems pretty weak, and yet you guys have a pretty optimistic forecast on the top line there next year as well. So I'm just wondering if there's a little more color we can get on that.

Yes, we have been working -- this is Don -- we have been working for quite a while now. Some of the major things that we've done in the last several years really we are seeing some of the benefits from that today. And those are for instance the consolidation that we made through the past several years on a number of facilities and operations we had in Europe. We're starting to see the benefits of that.

We still have a few ongoing closures and consolidations. And we probably well at all times, but the majority of that has been done. The consolidation that we had in all of our warehousing into two major EDCs in Europe is pretty much complete. And that generated savings for us on the warehousing and logistics side of the equation.

We have moved more jobs east into Poland and to the Czech Republic. We doubled the size of those facilities, which certainly helped tremendously. And then the big one that no one really has really talked much about -- we have -- but I'm not sure that anyone really appreciate the significance of it, was the major Big Three trading subsidiaries that we started in the UK, France and Germany. This is where about 80% of our business resides. And by bringing all of Parker -- that enabled us to have a one face to the customer, if you will, in those three countries.

And by bringing all Parker together under that structure -- where we now have a Managing Director for the entire Germany. We have one for France. We have one for the UK -- really enabled us to serve the customer a lot better. I think we are seeing additional volume as a result of our better service over in Europe, and the fact that we're able to offer complete systems solutions for the customer. I think we're gaining ground there very rapidly.

And so that -- I wouldn't underestimate the impact of our sales and structure -- our trading structure that we have implemented in those Big Three countries. So that is pretty much -- I would say the majority of it, with the exception of the Wynn initiatives, of course, we have been driving inventory down in Europe as well. We have been working the purchasing program, the strategic purchasing and the strategic pricing initiatives very hard over there, just like we have been here in the U.S. and elsewhere around the world. So all of that really combined, and I can't give you a split on how much came from each with any accuracy. But I can tell you that it all adds up into the performance that you're seeing.

And the top line strength for next year, are there end markets or regions, or how should we look at that?

I think we're just seeing basically, with the exception of France, which has been basically down as one of the weaker areas of Europe, I think basically everything else pretty much we are seeing some positive movement in. As I reflect back on the forecast from our trading subsidiaries a few weeks back, it is pretty broad based.

And then Tim always used to tell us that there's no way that this industrial rest of world margin could catch up with North America, but it is starting to look like maybe he was wrong.

No, I hope I am wrong. A lot of people around here would like to prove me wrong. But I guess I wanted to put some caution that, as we know, there is clearly are cultural differences and structure differences over there. We thought that -- we should be able to get real close to 15. That last 200 basis points could be real tough. We should be able to get it close. And I think with what we are seeing now, we're hoping 15 is doable as well.

Gary McManus of JPMorgan.

Great quarter. Can you talk about the 7% growth in aerospace -- can you break that down between defense and commercial?

This is Tim. To tell you the truth right now I can't

But just -- obviously I think you're suggesting much stronger growth in commercial. Is that fair?

That is fair. What we have seen is a rather steady-state out of the military defense side, which was -- has been elevated but relatively steady. So yes, the pick up, without being able to give you the exact numbers, have occurred on -- more on the commercial side.

But you don't expect any decline in the military defense side?

No, we're not looking for that. And I think Pam articulated quite well earlier what we have -- starting last year we had a lot of people start flying again, especially for business purposes. Planes did start to come out of the desert. That creates a great surge in the MRO after market side to get all those planes back in service, and the nicer margins. Now of course that is leading to people ordering these new jets, and the nice pickups on the OE side. So that is what is occurring.

I am still a little confused on why we won't get any aerospace margin improvement. I think commercial carries lower margins, but I assume the incremental margins are good on commercial. So if military is roughly flat and commercial is up 10, 15%, when do we see an improvement in overall aerospace margins?

There is a couple of issues on that. And first of all, frankly let me just -- I think most people are aware that on the commercial side you make -- you are lucky if you make money. Let me just say it that way. You always have new programs coming along. There's a lot of developmental costs, nonreturning engineering, that you're absorbing. And maybe you do make a little margin out off the OE. But the bulk of all the money is made in the after market.

And part of the issue is that developmental costs and the nonreturning engineering are built into the programs. As Pam said, we're thrilled we have won some great new business on some new programs. The downside is, is we have got to go out and spend millions and millions of dollars right now to bring those programs onboard with no revenue.

Just my follow-up. Capital spending was below D&A by $100 million for the third year in a row. Is that sustainable? What is your expectations for '06 capital spending?

Your observation is exactly right. It has been 2%, surprising us even. Coming typically out of an expansion this long, we would be back up around the 5% level. We -- in looking at the plans for next year all the groups have come in now. And this is a good news I think for all of us in general, for the whole industrial sector. All of our groups came in saying, we can no longer run at these levels. We are going to need more capital. We're looking to be least in the 3, maybe the 3.5% of sales. We don't want -- we don't think we will go up -- back up to the 5%. But every group came in looking for more capital, so that will be occurring. And we feel -- that makes us feel a little good about the year, because when people start spending on CapEx, that helps us keep going here.

If I take 3% of 9 billion is 270 million -- is that what we're talking about this year?

Yes, 3 to 3.5.

Ned Armstrong of FBR.

You in the past have stated that you believe that you can get our operating margins ultimately to 15% or possibly better. What do you anticipate the timing of that to be, and what do you anticipate the biggest obstacle in achieving that?

We haven't set an exact time. I think the timing -- this is Don -- the timing really depends on a lot of things. As you have seen we have come back from about 6% margins now to where I think the quarter ended up around 13. And I think a lot depends on just a continuation of the good work we have done in the Wynn initiatives, which are ongoing and we're still getting a lot of traction there.

The consolidations are pretty much behind us. I think the other thing that you'll hear about a little bit more is we're ramping up innovation to a new level. I think that all plays a big part in getting to 15. But I think on the downside it is typically -- what works against you a little bit is acquisitions. And I think, as you know, when you're buying about 5% of sales and acquisitions, at least in their early year, or in their first year, you normally -- it detracts from earnings. So it is always good to look at how you're doing with and without acquisitions, because it does distort that picture a little bit as well.

But we're dead set on that. I think the important thing that for you to know is that when we talk about financial performance at Parker my focus is return on invested capital. I think that the most important metric for this Company is to be driving return on invested capital. And our stated goal, and I have been talking about this at every conference I have been at, is we want to get into the top quartile of our diversified industrial as far as return on invested capital. And we can do that, it appears, without getting to 15%, because I just -- just we stated earlier in the press release, we're there. We have now had performance in that top tier the last two year.

And that is where I want to be. I think that is what really drives shareholder value at the end of the day is being able to generate returns up in that high level. And we're competing for capital along with the rest of those companies. And we think the smart investor will take note of our returns relative to everyone else.

So that 15% is wonderful. It is a goal that we're continue striving for. Do I need to be at 15 to be the best as far as return on invested capital, I don't think so. Because we're working both the numerator and the denominator of that equation real hard.

I would just like to add something to that, Ned, and that is that we do have strategy deployment throughout our Company. And so that 15% gold that Don talks about -- that is not only a goal of his, but that goal transcends all the way down to everybody in this Company. So we have a very detailed deployment system, so everyone understands that is where we are trying to get to.

Mark Koznarek, FTN Midwest Securities.

I have a question -- could you clarify, Pam, what the PIM was for '05?

40 to 50 million. It was 40 to 50 million, and we are in the ballpark of 40 this time.

Okay. Now despite the headwind this year of 40 to 50 million, you still rolled out incremental margins across your business on a full year basis that were in the 30% range -- at North America, even better. But when you look at your guidance, just putting the numbers together, it really points to a pretty significant fall off in that incremental margin. And you cannot really point to the PIM as being worse; it is the same, actually a little bit better. Raw materials, I imagine, are beginning to at least stop going up. And you have got pricing momentum from increases that you have announced in the past few quarters.

So what is wrong with this picture? It doesn't seem to add up. The leverage seems like it ought to be better for '06.

I think that part of the issue, as you get deeper into the expansion, clearly -- our goal is to try to deliver the 30. And we have the first 6 quarters of this expansion. And hopefully, at the end of the year, we can deliver or get close to it. But again, frankly, it gets tougher as you get into it -- to maintain that high. And so I think they're -- that is part of the phenomena there that is built into the plan.

Tim, could you maybe clarify that just a little more? What becomes tougher? Do you have to give back some of your price gains, or are you spending a lot of money on manufacturing inefficiencies because your volumes are so strong, or what is it that is tougher?

Well, we have been working the people very, very hard. And they are all signed on board on the lean initiatives and increasing productivity. But you get to a point where you just have got to bring some workable on board. And when you bring people on board, they are not as efficient. And you've got that those issues in startup.

We spoke earlier about the CapEx. And we know we are going to increase the CapEx quite a bit. And that is an immediate increase to the CapEx expense, and that takes awhile again for the equipment to come on board. And there are some inefficiencies that occur, et cetera.

So it is those types of things. It is very normal, standard things. We will still strive to deliver as much as we can. Now, there is a very key metric around here is watching that 30% -- what we call MROS. But it does get tougher as you get into it.

Okay. Then, just a clarification on the guidance -- when you talk about the revenue expectations, that incorporates acquisitions that you did last year that we still have -- like benefits that roll into '06 -- like a deal that you did in the fourth quarter. Your outlook captures that revenue within the guidance. Is that right?

Correct.

That's right.

Okay, so really, to look at base growth, we would carve off 1.5 or 2%, something like that. That seems to be, by my math, what the carryover is of revenue (multiple speakers)?

That is a fairly good estimate, Mark. But one thing that I would like to say is that when you look at the guidance going forward, we have always talked about 30% marginal return on sales. And that is kind of where we wanted to be. And if you look at the plan, you really look at the guidance, you will see -- at the high end, we are pretty much in line with that.

Robert McCarthy, Robert W. Baird.

I just wanted to follow up on something Don said when you are talking about operating margin, Don -- I thought I heard you say something about 13% in the quarter.

What was it?

The quarter was 20%. But when you add back the acquisitions, it is substantially higher than that.

Did I -- is that something I stated?

You know what, rather than do that, why don't I just ask my question? Don, when you talk about targeting a 15% operating margin, are you talking about operating margin as reported for the consolidated business, including corporate overhead? Or are you just talking about the average margin of the reported segments?

If I look at -- for the 3 months ended June 30th -- I am just looking at my sheet here, total segment operating income was 287 million. On a 2.2 billion, it comes out 13%.

Okay, and that's the calculation --

That is right off our consolidated statement of income. In other words, you have that as part of -- I think that is part of your (multiple speakers).

Now, that is before the corporate G&A, Rob.

And so then to my question about the 15% target?

What about it?

Well, would it include corporate overhead?

This is would be at the division level.

No, this is operating segment income. (multiple speakers) before (multiple speakers).

Very good, thank you.

But I thank you for asking that question because that question has come up several times. There is confusion out there with respect to that. So I thank you for asking that.

John McGinty, Credit Suisse First Boston.

Okay, John, you always seem to ask a question I am not quite in line with, but (multiple speakers).

I am going to start with two clarifications. One, the FAS 123R, the $0.15 to $0.20 impact on fiscal '06, where is that going to show up? Is that going to be a line item? Is that going to be spread throughout the divisions? Where are we going to see that?

That is a very good question.

Those will all be pushed back to the individuals' cost centers. Okay? So it will get -- be pushed back both in the cost of goods sales area and the SG&A. But it will come out of the segment results.

So the segment results will be lower by whatever dummying $0.15 to $0.20 backup to an operating number or pretax number. But is it going to be more in North America and in aerospace -- I mean, nothing international? I just don't know where it falls.

Well, they are most in North America and Aerospace -- international, much less, but some impact. And again, keep in mind that down in corporate G&A, there will be in impact as well.

Can you give us what portion of it -- 20% in G&A, 50% in G&A? I mean, just because we have got -- we basically -- the models that we are going to do will have in it from day one. So we can take your guidance, but we have got to figure out how to back it into the guidance.

Yes, I think Pam is going to have to come back to you. We honestly and truly just do not have that information now. That is why we couldn't adjust this guidance for you. We understand you need that, and Pam will try to come back to you as soon as she can -- to everybody and give them that.

Okay, and a second clarification -- the tax rate, 30% next year, the tax rate was supposed to be 29% this year. That was the guidance last quarter. And it ended up -- if I got my calculation right -- it's 27.6. Why was it lower, and why is it jumping back up next year?

John, there is two things that go on in the tax world. One is, we are always trying to reduce the underlying rate, the steady underlying rate, okay? And then in addition to that, there are one-off opportunities that may present themselves over the course of the year -- one reason or another.

So that is really what occurred here. Within the year, I would tell you, the base rate, the underlying rate, is right now around 30%. And depending on how many of these one-off things we can do, we can maybe bring it below the 30.

This year, in particular, we had a very good project and outcome on some R&D credits that enabled us to come in at the 27.6. That is the same number I -- but what that was, was a catch-up of about 4 years. So even though we will have a benefit going forward, it is not going to be -- it is not 4 years worth. So right now, we have got to start you off at 30 because that is kind of the ongoing rate. And we will push the tax department to see what other projects they can come up with to try to bring it down lower.

So it is a number that may have some upside surprise or downside to the tax rate benefit to Parker, if you can get there?

Yes, for now, the safe thing is use 30. But if we can identify and implement, there may be some ability to bring it down a little bit.

And then my question, really, is on the other, which is gone. In other words, that was basically 18 million of income, which we simply lose. You are going to get some monies for it. But presumably, you are not going to get enough to earn $18 million on it. So does that just disappear? Or would you look at a buyback just to -- get that benefit back to us? Or do we just -- that is obviously another, if you will, $0.10 or $0.12 a share headwind negative kind of from where you were, right?

Well, you are going to have to -- exactly. If we didn't do anything and just put the money in the bank, we would have some negative arbitrage there for sure. It is a business actually. When we first got it, it had a much lower margins. Our team did a wonderful job getting it up to where it is. We hope to take the proceeds in, in this first-quarter, and we hope to redeploy those proceeds into maybe a business or two that is equally as good.

But with a 16% net debt-to-cap ratio, as Dan was saying earlier, you could do a hell of a lot without waiting until you get the proceeds.

Well, that is true; that is true. But we work as hard as we can, but it always takes two people to dance here.

And then one unrelated follow-up -- incremental margin is fine. Yes, it gets tougher. But to drop from 35% North American Industrial to 20 with a sales gain -- unless a lot of that sales gain is from acquisition -- and I guess that is really my question -- of the 6.5 to 7.2 in North American Industrial, how much of that is from acquisition? Because if not, it just looks like this is where you are really sandbagging on your -- I'm sorry -- being conservative on your estimate.

There is no acquisitions in the numbers, John.

In the North American, the 6.5 to 7 points has no acquisitions carryover in it?

Well, there is some carryover.

Yes, there is some carryover.

How big is the carryover -- is what I am asking.

There absolutely is some carryover.

Yes.

Do you have that number?

A couple points.

Okay. But it is still pretty darn conservative. Thank you.

Andrew Casey, Prudential Equity Group.

Good morning, Pam. On the acquisition question -- kind of slightly different than John was just asking -- given that you are generating very good ROIC, are you seeing more competition in any of the areas that you are interested in acquiring? And if so, is this kind of causing a little bit of a headwind?

Well, as far as the activity, there is a lot of activity out there. It seems like everyone has a lot of money to spend these days. And so we are seeing more people involved, chasing acquisitions.

It hasn't been a real major problem for us. I think what we are working on, I think we feel pretty good about. And remember that there is a number of companies that -- there is a lot of reasons why people sell their businesses, especially privately-held businesses that -- probably the first and foremost reason that they -- well, not the reason, but the one thing that they look at when they try to find a home for it is a company that is going to treat their people well. They realize that these are privately-held businesses that they built the business, not because of everything they did, but because of the hard work of their employees.

So a lot of times, they are looking for the right home, and Parker has typically been the right home in this space. When you talk about motion and control, everybody knows us. Everybody knows how we treat the employees. And when we buy companies, they feel confident that we are going to buy them to build them and not to tear apart. So that really gives us an advantage, I think, when we're in this -- looking at acquisitions, especially the privately-held ones that don't get into a major auction, that Parker just happens to be an acquirer of a home -- let me put it that way. We tend to be a good home for the business, and we have a good reputation along those lines.

Okay, thanks. And then if you can tie that together, you are comfortable that you can do something to offset the negative arbitrage that Tim and John McGinty realized?

Yes, we don't put new acquisitions obviously in the numbers. That is what I referred to before. There was some obviously carryover from last year acquisition activity in the new numbers. But there is no new acquisitions.

The problem I have is with every time I get the question is, what are you going to do with all of this leverage that you have here -- capability or capacity -- is that I cannot show you what I am looking at, okay? And that is the problem. If you saw what I was looking at, maybe you would feel differently about how we are working this, the balance sheet. So I think you'll just have to -- we will just have to wait to see how things progress here on the acquisition front. But I can assure you that we are looking at many things and many opportunities.

Joel Tiss, Lehman Brothers.

Great quarter. Can you talk a little bit to us about the distribution channels? What is going on in terms of -- I guess there was a little bit too much inventory in the channel before. Is it getting worked off? Where do we stand now?

I don't know that there was ever a lot of inventory in the channel. There are distributors coming out of the downturn. We're pretty lean actually. And in fact, what has happened as a result of our efforts on executing lean and Parker, we have been able to drive our inventory down from where it was several years back at about $0.19. Hopefully, the investment community has recognized that we are at about $0.19 per dollar sales back then, which we've said that we wanted to get it down to 12, and we are about 12.6.

And as a result of that, we have been able to take inventory out of our channel. And our distributors have recognized the fact that -- hey, we are servicing them. And they don't need as much inventory. So I don't think there is a buildup or has been a buildup here throughout this upswing of a lot of inventory build because we have been servicing. Our service levels are at an all-time high. Our late backlog is at an all-time low, and that is unusual. And I would have to tell you that we are getting business as a result of what I just said.

So I don't see a lot happening there -- pre-buying or anything like that or trying to stock up on inventory -- at least not with our distributor network. I am only speaking for ours now.

Okay, and just a follow-up -- is the return on invested capital, is that impacted by the PIM headwinds? And if it is or isn't, can you tell us what it would be excluding those right now?

That is a good question. I do not think we have calculated it. Of course, it would be impacted if it hits the return side of it. And anything there obviously would affect the numerator. So we could probably look at that, I guess. If you wanted to call Pam on the side, we could probably tell you what it would be.

But remember, this is just 1 year. I think we had in the first several years going back to '01, we probably had 200 to 250 million of PIM that we had overcome. So it has been a continuing headwind. But it is been offset completely and then some because of the WIN initiatives that we have been driving. And I wish that we didn't have the PIM because you could really see what we have been able to accomplish on the WIN initiatives just on their own merit. But it is what it is. And we are just dealing with it.

But I would say -- you could probably do a calculation, a matter of fact, knowing about the magnitude of what we have been incurring on PIM.

Ann Duignan, Bear Stearns.

I just had a follow-up question, but I think most of them have been answered. I was just curious about what you had baked into your outlook for acquisitions, but you're saying you have nothing in the outlook for new acquisitions.

As you know, as you understand the WIN strategy pretty well, and we have some key financial metrics here we measure ourselves against. One of which is 10% compound growth rate at the top line. And we have always said we thought about half of that would come internal, and half would be external acquisitions.

Of course, this year we managed to really exceed that by double on the internal and about hit the target on the external. But on a go-forward basis, we would be looking to land about 5%. So with an $8.2 billion year, we would be trying to bring home a little over $400 million worth. And we clearly have plenty of capacity to do that. So that is what we would be shooting for.

Okay, and just reading between the lines from what you're talking about and what Don was saying, it sounds like your backlog for acquisitions is quite strong. Is it comprised of a number of kind of medium-sized companies? Or are there a couple of very interesting larger-than-normal opportunities out there?

You know, as we have said to everyone, there really isn't too many real big ones. There is not too many north of a billion kind of things out there for us to look at. Most of them, Ann, you're right, are sort of what we would call the midcap guys. A lot of the little guys are already gone. And we are now looking at sort of in the midcap range. So maybe a big deal in terms of us historically, but in terms of the percent of total Parker, not very large.

Okay, and are they more North American or rest of world?

Well, we are looking all over the globe. We, again, a lot of the consolidation has occurred in North America. As we know, the last couple of expansions, there is still more going on here. But there is probably more opportunities in Europe. And in Asia is kind of a mad scramble. There is -- but as we know, in China, there is not a lot of good things to buy. A lot of that you have to do greenfield.

But it is a global effort. But I would say frankly, right now, more opportunities were probably in Europe than they are in North America. But Asia would be the other one.

Eli Lustgarten, Longbow Research.

Nice quarter, everyone. Most of questions have been answered, particularly all the guidance excludes the impact of the options. My main question is -- you bought Denison over the past year, which is big European exposure and much, much higher European margins than Parks has been used to. And my question is, have you looked at your European operations and rickload (ph) operations and figured out to what degree you have really -- how much real improvement have you had from the Parker operation and how much reflects the Denison pull through from the -- because their margins have been in the high teens as opposed to single digits.

The big improvement we have had is from everything I have said earlier, Eli. Denison represented about -- as I recall, and I look at my European business, Denison was less than maybe 3% -- less than 3, maybe 2% of the total. So it is not going to drag the average up to the extent that we are talking about. This is a huge, huge improvement in Europe that was a result of many, many internal things that we did and the very minor impact by Denison.

So it is basically pure operational improvement as opposed to benefiting from the Denison distribution or strength of their markets?

Oh, I think Denison is a positive. Don't get me wrong. Denison has been a very, very good acquisition for us. But I will say that it did not drag our average up to the average that we are seeing here at all. That is not what I explained the delta. The delta is a result of all the work we have done on getting those trading subs set up in the Big Three, getting the inventory consolidated from 50 some locations to 2 or 3, and moving the high-labor content product to the Eastern block countries and doubling the size of those facilities, moving more work in there. And really, all the hard work that is in the consolidation of factories and facilities that we took on over the last several years is really what you can attribute the improvements there on.

And different follow-up -- what is holding down the profitability of North American fluid power business? It is not that it is not respectable at this point. But with the volume gains -- we have seen higher levels of profitability across the board in that sector. And I am just wondering what is holding it back from getting back to the 15% level, given the level of volume strength that -- because price pressures are what is holding it back from achieving more historical level results.

We are approaching it, is all I can say, Eli. We are getting it close, and our goal is still to get back to where we were. And with the improvement that we made in the last couple of years, I think you can see we are certainly heading in the right direction very quickly. We will just have to wait and see. We haven't given up on North America getting back to 15, I can guarantee you that.

Yes, I am just wondering what is holding (multiple speakers) is it still low-volume levels? Is it pricing?

Well, no. No, actually --

Is it mix, is it -- what's--?

The two areas that have had the big influence on North America has been automotive, with our CIC group, and it has been the Semicon kind of business (multiple speakers). And those have been negatives for us. Everything else has really been very positive. So I think -- if we end up getting a lot of these segments back to the levels and the profitability that they were, if the business comes back, I think we will be heading in the right direction. But it is really only two major segments that is kind of dragging us back a little bit now.

I just want you to see that -- this was being the strictly North American fluid power, which was 13.3 for the year -- 13, 13.7 the next couple of quarters. With these level of volumes, what is holding us back -- gives that to the sector, as you report it getting back to (multiple speakers) -- closer to 15%?

Well, Eli, the Semicon would be -- are you talking North American Industrial?

Yes.

Yes, certainly, the Semicon impact is in there. And also in there is the automotive from the seal side of the business. The automotive from the air conditioning is down in the CIC group. But there is a couple of those -- a couple of those things in there. And other than that, as I say, Don said, we are on a journey here, and we are going to get it there. We've got to have it there. That is our biggest segment. That has got to get there. It is committed.

Chris Coddlewigs (ph), A.G. Edwards.

My question is on R&D spent. You talked in the press release a little bit about incremental spending in '06. I would like to start by asking what was the rough spend for just the Parker share in '05?

Well, again, I know, -- we don't have that number yet actually. We are still tabulating that for the year. I saw the 10-K, and it has got a blank in that space right now. So unfortunately, Chris, we cannot give you that number yet. But go ahead.

Well, your run rate has been 130 basis points of sales, or 1.5% of sales, somewhere in there. So I would think it is around 120 maybe million?

I think it was up to -- well, I will accept the 100.5% -- a little more of sales, yes.

Can you quantify what -- it has going to be hard to quantify if you are not sure what it was this, what the increase is. But since you alluded to it in the press release, I thought I would ask.

Well, the important thing, I think, is really not the number. It is how you are using the money. And I think the important thing that I would like to leave you with is the fact that we have launched a very major new initiative in this Company. And it is called WINOvation. And the whole concept is -- just spend less and get more out the other end, okay? And that is the whole drive. It is not how much money we can spend here because we can spend as much money as we have got and then some and not accomplish anything.

This whole WINOvation concept, which we haven't had an opportunity to really explain in depth to the financial community, but I can just tell you -- it boils down to thousands of different projects and initiatives that we can take on as far as new product development and innovation -- boils it down into a very meaningful few that when we get these through the pipeline and get them to the finish line, they generate big returns for the Company.

So we are trying to deploy less capital more effectively and efficiently. That is the whole guideline. So I would not be misled by what the R&D spend is. We are going to get more for less going forward.

I understand what you're saying. It says in the press release, you are going to increase your spending. And that is the reason I ask.

So should I think in terms of certain segments really benefited more than others as far as your efforts? Or is this where we see opportunity?

It is across the board, and it is worldwide.

Alan Strauss (ph), Lord Abbett.

Good quarter. You guys talked about best-in-class performance. And I just sort of wonder what you think best-in-class performance means when it comes to optimizing the balance sheet?

Well, a best-in-class for our Company, as we have done our analysis and determinate what best-in-class looks like is a leverage of and a range not to exceed -- it could hit 40%, but we tend to think that 37 should be the max leverage. And if you look historically, 2 years ago, 2 or 3 years ago, we were up right up in that range. And it has really only been the last couple of years that we have dropped down, and it's 20.

So I think the question you are really asking is, again, do we intend to stay at these level? And the answer is -- no, we don't intend to stay at these levels. And we intend to get back up into the 30s, where we have been in the past.

And I know you cannot share the pipeline of acquisitions with us. But do you have a timeline in mind? And if you do not, if you cannot come to agreement on a bunch of acquisitions where they don't meet your financial criteria, that you will start a meaningful share repurchase program?

Well, I cannot give you any specifics. All I can tell you is that I don't think -- at this point, we are not considering a major share repurchase, okay? I am talking about something beyond what Tim has described earlier. And I cannot give you a timeline, because I do not know what the timing is, when these are going to get through the pipeline. So it is a tough one to answer.

But as long as we see opportunities to execute on our strategy and build the Company and achieve the kind of returns we are achieving for the shareholder, we are going to continue to work that side of the equation. And there are plenty of opportunities out there. I probably should just leave it at that. And it is really global.

Barry Bannister, Legg Mason.

Of the 6% organic in the quarter, did you break out what the price component was? And could you compare that to the quarter-on-quarter comparables? Is price getting better, worse, or what have you?

No. We did not break it out on price. And frankly, that is always one of the more difficult things to do. So we really didn't. But to your question of it is it getting any easier or any worse or what have you, I would say no. Neither. It is still a battle out there all the time.

You know, we do the distributor things every first of January, and every first of July. And we are routinely doing those. Not very big, but making sure we stay disciplined to do those. And those seem to be sticking okay. The pricing with the OEs -- again, it is a real tough battle. But right now, they are -- a lot of -- a little more concerned about getting parts than trying to squeeze the last nickel out of you.

And frankly, we have had some OEs who were refusing increases. And we respected that. We said we want to keep them as a customer and we respect that decision. But there are other people who do want the parts, and they are accepting it. So they kind of moved ahead of the queue. And usually, we work through things that way. But it still is very, very tough. But again, it has been.

I think we are keeping up with it. I think the bottom line is try to keep up with it. And I think that is -- we have not in the last year and a half ever been on the call saying that boy, we are really going to miss our numbers, because this pricing problem -- we have not ever said that. And we are just trying to keep it in balance.

When I think historically back to Parker's mode of operation, later in the cycle if (ph) you tend to make your big acquisitions and set yourself up to increase the returns on those acquisitions into the next cycle so you can be a bigger Company next peak. Last time, you bought Intertech and Wynn's for example.

But when you try to change the Company, here is what I am trying to ask, if you become a more high-end Company -- let's say high purity filtration vis-a-vis gear pumps -- you are going to be paying a lot more, incurring a lot more ROIC dilution, given your low price to book or whatever the price may be derived from debt. And I am trying to gauge the direction of the Company. Is it toward high-end apps, or is it towards going to be the same old Parker -- good core hydraulics and other businesses?

Well, I think yes, it depends on what you pay for acquisitions. I think the hopes are here that, of course, if we pay higher multiples or higher dollar per dollar sales, that the returns had better be higher as well, so the numerator is going to be okay on ROIC. You have got to look at both the numerator and the denominator, as far as I am concerned.

I think we can manage the 5% growth that we are talking about and pay it at multiples that you have seen in the past, and still drive ROIC and maintain it in the top tier of our peer group. I think we have demonstrated that. I think if you look back of what we have done over the last five years, we have done exactly that. And we have been driving that ROIC up all along. And maybe it hasn't been noticed, but hopefully people will start noticing it.

David Bleustein, UBS Warburg.

It is late, so I will be real brief. Just a real quick update on Semicon?

It hasn't changed much, David. Really, we had the ramp-up, and it has leveled off, and it is pretty much at that same level. Going forward, we are kind of looking at the first half is going to be fairly in that same level. However, I know when you read -- or at least what I have read, it really says that it is going to be a lot better in the second half of this year. At least it's -- maybe not a lot better; I am probably overstating that to some extent. But it is going to be better.

Really, we are kind of looking at it to be kind of flat, maybe moving up in the second half.

Okay. And Tim, any color on the price increase pushed through July 1 to the distributors?

No, no additional color. I think we rolled those out and they seemed to go fine. And that is about all. There's nothing -- it wasn't a major event.

What was the average price increase do you think?

I don't know. Don, you know what the (multiple speakers)

I don't know. I really don't.

There are so darned many of them, it is hard for us to do, David.

Mark Koznarek, FTN Midwest Research.

Just a couple of real quick -- would you guys estimate that your price increases have offset the raw material increases for the quarter and for the year?

Yes.

For both?

Yes.

Okay, good. And this was such a good quarter, I hate to pick on something, but -- (multiple speakers)

No, you don't.

I just want to understand the seasonality in the CIC business, because I would have thought that when we get into the degree days part of the calendar like this particular quarter, we would have strong base sales on the HVAC side and strong margins -- and I know there is auto in there. But the auto production was actually less bad in this current quarter than it was in the first quarter, but yet the margin is down. So is there anything weird going on in there? Or is that the seasonality we should expect that is actually the best the margin is going to be in the first calendar quarter?

I think it is just a mix issue, Mark. And as you look forward you can see that the (technical difficulty) business is coming on and you look next year, and they are showing some really good improvement. And going back a year, we said that for CIC that is what's going to be a pretty tough year because of the automotive. And it ended up being worse than we thought it was going to be. But on the other hand, you can see that things are kicking in next year due to some of platforms -- automotive, that is even a little bit better.

There are two big components in there that you are hitting on. The automotive thing, of course -- again, we are now getting into the summer doldrums. And there are a number of shutdowns that are built in there. And so yes, in fact -- first of all, you had the slowdown in automotive, and now you have got the summer of doldrums, and some of these plants are closed for model changeovers, and some are going to be closed longer than they would be normally. You have that going on.

Now, in terms of the air-conditioning, the residential/commercial, that is very strong in spring. And it sort of carries into the summer and then gets real slow in the fall. So there are some mixed dynamics there that are occurring.

In sort of a normal year, if there ever is such a thing, we ought to see your CIC performance about the same in the third quarter and the fourth quarter?

Yes.

John McGinty, Credit Suisse First Boston.

Very quickly, Tim, if you spent 400 million on acquisitions, and that was your number, you are going to use all of about -- if capital spending is 300 million, raise the dividend? You hit the midpoint of your earnings. You are still only to use 100 million of cash. You are going to generate about 3, 400 million of -- well, 450, 500 million of retained earnings -- your net debt to capital is going to stay at 16%.

So getting back to the questions on the balance sheet, unless you make $800 or $900 million of acquisitions, you are not going to make a dent in your grossly underleveraged balance sheet.

I will trust your numbers.

But -- so what do you -- so what happens? (multiple speakers) Don can talk about the pipeline, but is the pipeline that much bigger than the 4 or 500 million that would be kind of the 5% -- of 900 million -- 9 billion is what, 450 million --?

There is always plenty of them out there, John, but as I said earlier, it takes two people to dance. And I think to make our target within the WIN strategy, we said it is around 5% and that would be the 400 million.

But that still leaves you grossly underleveraged.

We clearly have a lot more capacity. And I think, again, there was a question of -- on share repurchase and again -- and dividends, and those are always on the agenda, as well. We look at all of those things. But we are not clearly going to do a lot with the dividends, because we have not in 50 years, and that has been a very prudent policy, so we have been able to increase them for 50 years. The share repurchase we will do and we will do more opportunistically, as we feel we are undervalued, and we will do minimum to prevent the creep.

But the real deployment of the cash will be for growth opportunities. Those could be internal, developing some of our internal growth platforms and spending money on that. The rest will be acquisitions. But those are the numbers. We always look at a lot of things. But as I say, it takes both sides.

And then final question, on Aerospace, (technical difficulty) (indiscernible) the commercial OE has traditionally been breakeven. But on the other hand, you all have been made the point that the regional just (ph) which is in commercial OE, are profitable on the OE side. The Airbus theoretically was supposed to be a different model than the Boeing model. Could you give us just an absolute number? Are we talking about the incremental spend for new programs '06 versus '05?

In other words, you win the programs, the spending that you have to do to get ready that you get nothing for because you are basically gearing up to spend -- are we talking $5 million in '06 versus '04 -- 10 million? Can you give us -- I am sorry, '06 versus '05. Is it 5 million? 10 million? Can you just give us an absolute number of spending in Aerospace on these programs that you will not get reimbursed for until you start to ship and get into the aftermarket? I mean, just some quarter of magnitude so we know why the margin is going down. Is it 5 million? 10 million? Can you give us a number?

It is higher than any number you have thrown out. How is that?

Okay, so it other words, '06 versus '05, there is going to be at least 10 million of just pure, incremental spending that gets wiped out? I mean, you will get it back later, but it is an outlay now?

(multiple speakers) Right. Probably twice that, John.

(OPERATOR INSTRUCTIONS).

Okay. Thank you very much for those who participated today. And I will be around this afternoon to answer any additional questions that you may have. Before we sign off though, I guess Don does have a couple of comments. Thank you.

Yes, I just wanted to recap for you some of our goals, and then how we are doing. I think obviously everyone has read the press release, so you know pretty much where we are. But there are a few things maybe we didn't touch on to any great extent. One is that -- I will say the number one goal for Parker has always been premier customer service. I wouldn't take this one very lightly. We don't take it lightly here. And it is not easy to do. Especially in this environment that we are in right now, our customer demand is at very high level, and many of our competitors are falling short here. Parker has measured up very nicely.

We do measure this metric around the world, and I will say that service is at an all-time high. And as I indicated earlier, backlog is at an all-time low. And I think that is something that we are very, very proud of at this Company. It is not easy to do, of course, with the demands as they are coming in.

And you can see we are not just throwing equipment at it. We have not been having to throw 5% CapEx at it to try to solve it that way. We have been solving it based on executing on our lean initiatives internally. And I think we are capturing business as a result of that service level.

On the financial side, the financial performance, that is our second goal. Certainly, we were ecstatic when we exceeded that number that caused so much consternation after the first quarter, that 450 number. We were really, really pleased that we came in at 455. That is another record, of course, for the Company.

As I indicated before, we are focused on ROIC. And we are in the top tier of the diversified industrials. I hope that we get recognized for having accomplished that, and hopefully the investment community will see what kind of a bargain this Company really is.

Cash flow was a record, and it has been a record for several years running here now. And hitting double digits on an operating cash flow is a tremendous accomplishment, I thought, for the Company. And that is tied in with, of course, the earnings being up 53%, setting another record.

Just a little bit about the WIN strategy -- I am not going to go into a lot of detail. But our 2 plus 2 plus 2 program, for those of you that have been tracking with us all along I can say now that if you remember what I told you back four years ago, that we were going to try to get 1% of margin improvement in '03, 2% in '04, 2% in '05, and 1% in '06 for a total of 6%, now this year we have exceeded the six points in one year to go. So that does not mean that this is finished and you are not win see any more benefits from the WIN, but it is to say that hey, we told you what we would do four or five years ago. We did execute, and we did get that six points of improvement.

The other thing I want you to look at is to take note of the inventory improvement that we have made, which is really indicative of the effort that we have put forth on this whole lean effort. We were at $0.19 per dollar of sales when we started this WIN strategy. We had a stated goal to get down to 12. We are now at 12.6. We finished the year at 12.6%. That is a new record for the Company, never been accomplished in the history of this Company.

On the financial goals, beating the financial objectives, we think we are doing pretty phenomenal here. On profitable growth, as Tim indicated earlier, our growth goal is 10%. We achieved 17. We are pretty excited about that. We set a new sales record at 8.2 billion. But more importantly, I touched on a little earlier, and we will be talking more about this as time goes on, this whole WINOvation initiative that what we launched this spring.

We brought in all of our key engineering managers from around the world. We launched this. We already see some real interesting things that we can invest in as far as new product innovation going forward that is going to give us a very distinct advantage in the marketplace. So we are very excited about this. It is early days, but this is just the beginning of the new phase for Parker and some new things that we have to look forward to going forward.

So, I guess that is just a little recap for you as to how we see our progress on those three goals. And again, we are off to a pretty good start in 2006. So we are hoping for another good run at it this year. Okay, that is all I had. And Pam, if you wanted to close it up.

Thank you, Don. Again, thank you for participating, and like I said, I will be around to take your calls this afternoon. Bye.

Thank you, ladies and gentlemen. This concludes today's Parker Hannifin fourth-quarter 2005 earnings release call. You may now disconnect.