派克漢尼汾 (PH) 2006 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the third-quarter 2006 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 session. (OPERATOR INSTRUCTIONS).

Ms. Huggins, you may begin your conference.

Good morning. This is Pam Huggins speaking. I'd like to welcome you to Parker Hannifin's third-quarter earnings release teleconference. Joining me today is Chairman and Chief Executive Officer Don Washkewicz and Executive Vice President and Chief Financial Officer Tim Pistell.

Before proceeding to the earnings release, just let me take care of a couple of administrative matters. As is customary, I'd like to call your attention to the first slide, which is the disclosure on forward-looking statements and ask that if you haven't already done so, please read it in its entirety.

Moving to the second slide, this slide indicates that in some cases, in order to provide meaningful comparisons from period to period, non-GAAP financial numbers have been used. Where applicable, these non-GAAP numbers have been reconciled to the appropriate GAAP numbers.

For those online today, you may follow along with the slides that have been presented. For those not online, the slides will be posted on the IR portion of Parker's website at phstock.com.

Moving to slide 3 now, which is the agenda, the call will be in four parts today. First, I'll provide an overview, including some key performance measures for the quarter and year to date and concluding with the revised outlook for the remainder of fiscal year 2006. Don Washkewicz will then follow with a few comments on the quarter.

After that, we will be happy to take any questions that you may have. And once again, I ask please limit your questions to one at a time. In this manner, everyone will have a chance to participate. For the fourth part of the call today, Don Washkewicz will close with some brief remarks.

Starting with the highlights, as you read in the press release this morning, Parker has again enjoyed another record quarter of sales and income from continuing operations. The strength in Parker's end markets, of course coupled with the order growth, provides confidence that this high level of performance will continue for the remainder of the fiscal year.

Moving to slide number 4 and beginning with earnings, starting with the top row of the chart, earnings per share on a GAAP basis for the quarter came in at $1.46 versus $1.15 in the third quarter last year. However, as you can see in column 2, that $1.15 from last year includes $0.01 charge from discontinued operations. This was the divestiture of the Wynn specialty chemical business that we talked about last year at this time.

In the third quarter of this year, earnings included a $0.03 gain from litigation resolution and an expense of $0.03 related to FAS 123R, or what we term equity-based compensation. Removing the $0.03 gain as a result of the litigation and the $0.03 charge related to FAS 123R from this quarter's earnings results in earnings per diluted share from continuing operations this quarter of $1.46. This compares to $1.16 for the same quarter last year, of course after removing that $0.01 charge from discontinued operations. This represents a 26% improvement.

And starting at the bottom of the chart and working back, removing the $0.03 related to FAS 123R taken in the quarter gives an adjusted number of $1.43, comparable to and of course above the analysts' mean estimate of $1.39.

Moving to the next slide, slide 5, this slide compares earnings from continuing operations for the third quarter and year to date versus the same periods a year ago. While this can be seen from the previous slide that we just looked at, I think it's important to point out that EPS for the third quarter was $1.46 and year to date $3.73 versus $1.16 last year, and on a year-to-date basis, $3.13, a 19% improvement year to date, and of course 26% for the quarter that I just mentioned.

Moving to the next slide, slide 6, the strong earnings growth on a consolidated reported basis here, not on a segment reported basis, in the quarter is the result of a 180 basis point improvement in the gross margin, led by a 37% increase in segment operating income in the North America Industrial segment, proof that the Wynn strategy is still producing results. The line item other also contributed to the earnings increase as a result of the income recognized as a result of the litigation resolution.

However, earnings were partly offset by higher selling, general and administrative expenses due to higher compensation in connection with bonuses this quarter; higher interest expense, albeit minor and as a result of acquisitions; and higher taxes as a result of higher earnings and the tax rate increase increasing to 29% from 28.5%. And this is due to the delay of the approval in Congress of the R&D tax credit.

Moving to the next slide, slide 7, as shown on the slides live, looking at the top line, sales for the quarter were up 18% over the same quarter a year ago, of course increasing to 2.5 billion from 2.1 billion. And of this 18% sales growth, 9% came from acquisitions, 10% organic growth, and of course we lost 1% from currency, mainly the euro.

So as you can see, our Win Strategy has set a goal for -- we've set a goal to grow 5% from acquisitions and 5% organically. And as you can see, we are happy to again report we're meeting our goal to grow this Company year in and year out.

Just as importantly, we experienced positive core sales growth in the quarter across all of our business segments, and of course, across all of our main geographic regions.

Moving to the next slide, the strong double-digit sales growth in the quarter is partly the result of continued industrial end market strength. Of course, distribution remains strong. Strength at the OEM level in mobile and general industrial end markets and continued progress in emerging markets. Also, successful acquisitions -- for example, I'm sure you are aware we acquired 70% of the shares of Kuroda in the quarter, with annual revenues totaling approximately 50 million. And of course, the aerospace side of our business continues to remains strong.

Moving to the next slide, segment reporting and income from operations -- starting with the industrial segment, specifically North America, operating income is 38% higher on a year-over-year basis and margins increased from 13% to 15%, reaching Parker's goal of 15%.

For the third quarter, core sales increased 8%. Acquisitions added another 7%, resulting in a total sales growth of 15%.

Moving to the next slide and continuing with the Industrial segment, moving to rest of the world, operating income came in 57% higher than last year. And operating margins increased from 10 to 13% in the quarter, and on a year-to-date basis from 11% to 12%.

Core sales increased 12%. Acquisitions added another 19%. However, we lost 7% as a result of foreign exchange, again, the euro, resulting in a total increase in sales of 24%.

Of course, the main drivers of sales and operating income growth in the Industrial segment are the continued strength in our end markets, the acquisitions strategy that we're deploying, running more product through the current facilities and the continued success of the Win initiative.

On the next slide, Aerospace segment, operating income for the quarter is 23% higher on a 16% increase in sales. This increase in operating income on a year-over-year basis is the result of higher volume; a higher proportion of MRO business in spite of the macro shift to commercial OEM business, which carries a lower margin; and of course, the new product program, Win, development costs that we've talked about.

The current strong margins in Aerospace are in line with the expectations, however, that we have previously articulated. And they are in line with the annual guidance that we previously issued.

Operating margins in that segment increased from 13 to 14% in the quarter, but on a year-to-date basis, margins are down 1% from last year. And obviously, that is for the reasons that I just mentioned, and again, just to reiterate, in line with expectations.

Moving to the next slide, Climate and Industrial Controls, operating income is down by 3 million for the quarter versus the same quarter a year ago, and operating margins declined from 12 to 9%. This decline is the result of moving manufacturing to a lower-cost region and restructuring activities, mainly plant consolidations. Again, this is something that we talked about on the last conference call. And the savings from these actions haven't been realized as quickly as anticipated.

Sales, however, in that segment continue to climb. They were 19% for the quarter. Of that 19%, 11% came from acquisitions and 8% organically. As you recall, the Herl and the Kenmore acquisitions closed in the first and second quarters, bringing us a larger proportion of higher-growth refrigeration business.

Moving to the next slide, I'm just going to talk briefly about the year-to-date results. For the first nine months of fiscal year 2006, sales increased 15%, moving from 5.9 billion to 6.8 billion from the same period last year. Cash flow from operations reached a nine-month record of 610 million, 9% of sales, surpassing 498 million in the same period last year. Last year was 8.4% of sales.

Fully diluted earnings per share increased to $3.97. That's up 19% from the $3.68 per share reported a year ago. And fully diluted earnings per share for the first nine months of the current fiscal year include a gain of $0.03 per share from litigation resolution, a loss of $0.08 per share from the divestiture of the Thermoplastics division, and an expense of $0.16 related to FAS 123R. And of course, there was $0.24 from discontinued operations.

If you adjust for these, earnings from continuing operations was $3.94, and this compares to $3.13 for the first nine months of fiscal year 2005. The $3.13 is derived by beginning with the reported earnings per share figure of $3.68 and adjusting for a gain of $0.55 per share related to discontinued operations. And the table that was at the beginning of the presentation bears this out. So please refer back to that table.

Moving to orders -- talk about orders, our recent order trends, our orders gained strength during the quarter across all segments. We are particularly pleased with the order growth. We think that it provides further confirmation of the expected strength in sales as we move ahead to the fourth quarter.

Orders, as you know, are stated as a percentage increase over the prior year and they exclude acquisitions and currency. In North America, order growth was 3% in March on top of 5% growth a year ago. And of course, that's on top of 24% two years ago. This illustrates that order growth remains at a robust level.

Rest of world order growth in March was 2%. And that's on top of 4% growth a year ago. And of course, two years ago, it was 16%. Again, as you can see, orders remain at a very high level. The strength in the Industrial segment is the result of strength in general industrial and mobile markets, including mining, oil and gas, power generation, heavy-duty trucks, process and the semiconductor markets.

In the Climate and Industrial Controls segment, order strength continues to be seen, largely as the result of the new seasonal energy efficiency ratings, or what we refer to as SEER. Orders grew 14% in this segment in March.

Aerospace continues to be strong on both the commercial OEM and MRO sides. Orders were up 23%. And of course, this is on top of 12% growth a year ago and 11% the year before that. Remember that Aerospace, due to the volatility from month to month, is reported on a 12-month rolling average. So orders through Parker distribution channels continue to be strong. And as you know, Parker serves some 1200 markets, which helps mitigate any volatility in specific sectors.

Moving to the balance sheet briefly, our balance sheet remains strong. Cash on hand at the end of the quarter was 250 million. Inventory in terms of DSI is down to 63 from 69 last year. Accounts receivable in terms of DSO is flat versus the same quarter a year ago.

Cash flow, the next slide, Parker continues to have strong operating cash flow that I mentioned earlier -- 610 million, representing 9% of sales. And of that 610 million, we used 153 million for acquisitions, which represents 2.3% of sales. And acquisitions -- I said acquisitions, I'm sorry, capital expenditures. Acquisitions accounted for 810 million, increasing the debt outstanding by about 435 million versus last year.

So the debt to total cap ratio last quarter of 31% decreased to 27.1% this quarter and is higher than the 22.2% a year ago. On a net basis, the debt to total cap ratio decreased to 23.4%.

So now I will move to guidance, quickly. As I said, strong orders indicate favorable market demand as such double-digit sales growth is expected for the year. And margins are expected to further improve, delivering a record earnings and cash flow performance for the year.

So as a result, the lower end of the guidance is being increased. The guidance is moving from $5.05 to $5.30 per diluted share from continuing operations to $5.15 to $5.30 per diluted share, again from continuing operations.

Please remember that the guidance issued last quarter did not include the $0.08 loss related to the divestiture of the Thermoplastics division. And as advised last quarter, this guidance is after the expense related to equity-based compensation. The guidance today of $5.15 to $5.30 continues to exclude the loss on the Thermoplastics division, but it does include the expense associated with equity-based compensation. Please note that the guidance does include the $0.03 from the litigation resolution. So equity-based compensation expense so far this year is $0.16 a year and is projected to be no more than $0.20 for the full fiscal year.

So now getting into segment sales guidance, starting with sales, North America Industrial sales are projected to increase 13.2% to 13.6%. Rest of world Industrial sales are projected to increase 17.5% to 18.2%. And Aerospace sales will increase 8.8% to 9.2%. And Climate and Industrial Controls sales will increase 20 to 22%. So this guidance is above the second-quarter guidance. As you know, we had a great third quarter. We expect to duplicate that in the fourth quarter.

In terms of margin, North America Industrial margins are projected to be in the range of 14.8 to 15%; rest of world Industrial margins in the range of 11.9 to 12.1; Aerospace margins, 14.4 to 14.6. And the sales and operating margin increases, again in excess of the second-quarter guidance, are a result of the third-quarter performance and the strength in the end markets as evidenced by the order growth.

Below segment operating income, or what we term here below the line items, are as follows. Corporate administrative expenses will increase in the range of 18.5 to 19.5% versus fiscal year 2005. Of course, this is due to higher compensation expenses associated with the bonus programs.

Interest expense will be up 16 to 17% versus 2005. This is due to acquisitions. Other expense income will be up 35 to 38% over last year due to equity-based compensation and the pension expense. And the tax rate for 2006 is projected to be 29%. Now, this is down from 30% projected at the beginning of the year. But it is up from the 28.5% guidance given at the second-quarter earnings release. This is due to the delay of the R&D credit, as I mentioned earlier.

At this time, I would like to turn it over to Don. He has just a few comments related to the quarter. And after that, we will be happy to take any questions that you have. Thank you so much.

Well, good morning, and I'd just like to just spend a minute here just emphasizing just a few points. First of all, needless to say, we are very, very pleased with the third-quarter results. And I want to thank all of our employees worldwide that worked very hard to make this happen.

Just a couple of comments on growth. First of all, just to point out that we did grow 10% organically -- I don't want that to get lost in all the numbers that you did hear. We grow 10% organically, and that is out of 18% total growth for the quarter. So we are very, very pleased with that. As you know, our goal is 5% organic. So we are well ahead of that goal on organic growth, and that should be noted.

Industrial distribution -- another point that I would like to make is that represents about half of our business for the Company. I've been talking about that in the last several teleconferences. It's running about double digits now. So it is still running very, very strong for us and growing very, very nicely worldwide.

A couple of comments on orders. I know there was a lot of discussion on orders when we released the orders -- a lot of concern and so forth. But when you take it and you blend it all together, all of our March orders in total, our orders were up about 6.5%. That's against a 5% goal. So we were not concerned about the numbers in March at all.

Aerospace, our long-cycle business, it should be noted, was up 23%. And that is the nice thing about Parker -- you end up with a nice blend of Industrial and Aerospace. And one can be up, the other one might be down, but overall we're doing very, very well.

And then the last point I guess on orders that I would make, and kind of the way we look at it here is that one month doesn't make a trend. So I would not get too excited about any one particular month on orders. You'd really need to see three months going in one direction or the other before you really establish a trend.

Earnings at $1.46 were also great, and they were pretty much in line with our plan, and that's up over 26% over last year. I think you have seen that cash flow continues to set records. And we expect hopefully to set another record for the total year on cash flow. We continue to rank in the top quartile. As you know, that is one of our goals and stated goals is we wanted to be in the top quartile of our diversified industrials peers on ROIC. And we continue to rank in the top quartile there.

And then just to point out, you probably saw the announcement on this on our energy recovery system we just introduced just recently. And it was a real hit at a recent show. It is just one example of what we're working on in our Winnovation initiative, new product innovation and new things to come for the future. So you're going to hear more about that as time goes on.

So those are just a few comments that I'd like to make. And then I guess at this point we will open it up for questions.

(OPERATOR INSTRUCTIONS). Ann Duignan, Bear, Stearns.

It is Ann Duignan of Bear, Stearns. Nice quarter. I was going to ask about Q4 guidance, as it looked a little bit lighter than maybe people have anticipated, but I think you have walked us through the puts and takes. And my takeaway is that while the operations are performing better, you've got some puts and takes on the nonoperating line items that are offsetting the strength in operations. Is that -- bottom line, is that the way I should interpret your fourth-quarter guidance?

Yes, and this is Tim Pistell. I think you are right. Again, our plans for this half always were for two quarters to be pretty much the same. You people had a little lower in the third, a little higher in the [fifth]. But when you add them together, basically you were where we were for the total year.

So there are puts and takes, but that's kind of how it works out. And we'll point out that we actually do lose -- this first quarter was very strong. We had 64 workdays here in the U.S. We're going to drop down to 63 in the fourth quarter. And in Europe, we are actually going to lose two workdays. So that's part of why we had those kind of the same.

Okay, so nothing significant has changed other than a couple of puts and takes. Just a quick follow-up on international -- this current quarter looked like -- I think you said current organic growth on a constant currency basis was up 19%? Is there any market or region of the world that you've seen some significant acceleration in? I mean, that's a very strong organic growth rate, if I am interpreting it right.

Ann, no, I don't think you are. Then seems to be high. We had -- you know, there were a lot of acquisitions that came in to rest of world this year, a lot of the acquisitions that we did. But the organic growth was not that high. We had 24% total growth rate, I think it was. And of that, most of it was acquisitions. The actual organic growth was around 5%.

And have you see any strengthening in any of the regions outside of North America or any of the end markets outside of North America in particular? Anything of note?

Not in America. If you look at Latin America, you know, we have talked in the past about farm and ag being a real drag on Latin America. But I have to tell you, in terms of what we're seeing down there, farm and ag is a little weak, but it is being offset by some of this strength in some of the other markets. Construction, for example, is very good. So when you look at the orders now, what we're seeing is Latin America doesn't -- it's really not down. So we were quite pleased with that. And of course, Asia-Pacific continues to do really well.

I just want to move back here a little bit, though, on your question and third quarter, just to clarify the numbers. Industrial rest of world as reported was up 24%, okay, just for the quarter. And without acquisitions, divestitures and FX, it was up 12%.

Okay, so 12% would have been organic?

That is right.

At constant currency. Yes. Okay.

And what we had in the guidance was the 5% that I referenced last -- second-quarter guidance. I just wanted to clarify that.

Thank you for the clarification. I'll get back in line.

Gary McManus, JPMorgan.

I think you said me -- Gary McManus, JPMorgan. On the two items that cancel each other out, the litigation settlement and the stock option expense, were they both in the 7 million or 6.9 million of other income? Because I'm wondering, that is a high number. And if they both cancel each other out on a pretax basis, what caused that pickup in other income?

Gary, I want to clarify this just a little bit. When you look at Thermoplastics on a consolidated basis, okay, Thermoplastics is in other and it's about 11 million, okay? And then segment, it's also [an input]. And then the other income, that is also in the consolidated number.

I am looking at your P&L, and your other income is roughly $7 million, and it is typically around 0. And I am wondering what caused that pickup, especially considering -- I assume on a pretax basis that the litigation settlement canceled off with the stock option expense. Or maybe that's not the case?

Gary, this is Tim. On the other income and expense, you are absolutely right. In the quarter, in the most current quarter, and you're seeing that 6.9 million credit, that essentially is all the litigation settlement. Okay? And then if you go over to the year to date, which is sitting at about a $4 million expense, debit, that is the net effect after you put the Thermoplastics at about 11 million against it.

I know that Thermoplastics occurred earlier in the -- I'm just talking third quarter. So is the stock option expense in that 6.9 million other income?

No, no, the stock option expense is up in -- a portion in SG&A and a portion up in cost of goods sold.

Second question is on -- there was a lot of talk, as you know, with the slowdown in the North American Industrial orders. It was only up 3%, and in the previous months was up around 10%, at least for three or four months in a row. Do you have any read on April? Is it looking more like the 3% number? Or is it looking more like it was before, a 10% number?

Gary, could you repeat that question?

Yes. March orders -- North American industrial was up 3%. In the previous months, before March, it was up more like 10% on average, I think in the last -- the prior three or four months. So is April looking more like the March order [multiple speakers]

Okay, I got you. I just wanted to make sure that I understood. What we can say is -- I don't know, do you want to talk about April orders, Don?

What I can say is that March -- when you look at March orders, obviously, you were concerned about the number. Let's just say that March is an example of what is happening in April. Is that good enough?

So April is kind of tracking how March looked, basically, thus far?

No, no, the opposite.

I'm sorry -- well, then, repeat what you said -- it's looking more like the prior months' 10% type of growth?

I am saying March does not look like April -- or April does not look like March. Is that clear enough?

Okay, I think I got that. Thanks.

This is Tim. Let me jump in on two things. First of all, on the March orders, which was a very interesting reaction in the market, we reported plus numbers, plus on top of plus, still pretty good levels, but okay, increasing at a decreasing rate, we accepted that. But it's a real over-reaction.

The one thing that I would point out to all of you who follow Parker, I went back and I looked last year, last summer -- in North America Industrial, we reported one month at zero and one month at 2 and one month at zero. Now, this goes back to last summer. And I don't think -- well, anyways -- and here we are, nine months later, giving you some plus 18% sales.

So I think what we're trying to say here -- there can be anomalies that can make a month spike up or drop down a little bit. And you really do need to average those over three or four months to get a real sense. And that's all we would say, because we've been through this before if you looked at the history. And March was a 23-day month. And that will tend to pull down the daily averages, by the way.

Gary, the other thing I wanted to look back on, though, too, because I just -- not to be confused, there are two lines of other expense. There's the one that is up in the consolidated income statement. And I think -- we answered your question on that. That is where the credit litigation is this quarter, and year to date, the litigation in the Thermoplastics.

Now, when you go down to the segment portion of the income statement, that other expense is obviously a very different number. And a lot of other things go into there, one of which is stock compensation expense is in that other expense line down in the segment portion, okay?

I hear you. I got it. Thanks for the clarifications.

Andrew Casey, Prudential Equity Group.

Just to revisit the guidance question, I understand the March/April stuff in terms of the orders and the calendar effect there. But in the guidance, you have kind of a slowing implicit in the top end of the 530, kind of a growth rate which is good -- it is somewhere around 15% year over year versus the roughly 23% in 3Q if you exclude the litigation.

What are you seeing out there that kind of explains the difference in the growth rates, especially coming off a 10% organic growth 3Q? Is it just the workdays or are we running up against difficult comps? If you can help me there I would appreciate it.

Andrew, I'm just a little bit confused by your comment with respect to the litigation resolution because that's a below-the-line item which is offset by the tax rate. If you remember, at the second quarter we had said that the tax rate would be lower than what it turned out to be. So really the litigation resolution really doesn't enter into the guidance going forward.

Okay, but if you include that, Pam, in the third quarter, the growth rate actually goes up to more like 25, 26. So it makes the disparity between the fourth quarter and the third quarter a little more dramatic. I'm just wondering is it just workdays that you cited, or was it --

Yes, as Tim said earlier, yes, there's workdays that are in there. It actually works out to about two days international and one day for North America. So that's part of it. But really, our original guidance suggested that the third and fourth quarter would be relatively equal. And that's kind of what we're implying here today.

Chris Kotowicz, A.G. Edwards.

Good quarter. I don't I guess fully understand -- and maybe I just missed it, but CIC -- could you maybe add a little color here? Your full year, you've taken your sales forecast up, but you've taken your margin percentages down, and maybe I just missed the reason for that.

No, that's a very good question. We talked about this on the last call, and unfortunately we have to talk about it again on this call. But with respect to CIC, we did make -- we had some restructuring costs in previous quarters. Now, we did not have restructuring costs in this quarter, but what has happened is we anticipated that we would get the savings as a result of those restructuring activities much quicker than what we have been able to realize them.

The efficiencies, we moved to a lower-cost region and we moved a lot of machinery. We moved a lot of equipment. And we had to hire a lot of people. And unfortunately, we're not getting the efficiency as quickly as we had realized. So the savings are to come. They're just not coming as quickly. So it's really a timing difference. It's just being pushed out a little bit. So that's what you are seeing.

In addition to that, Chris, the other thing is that this group, we did a couple of transactions last fall. We added Herl, small one, and then we added Kenmore, which is a fairly large one. And we have been integrating those. And we are trying to do this on a pretty quick basis here.

So the bottom line is, right now, they have brought us quite a bit of sales. But they are having an impact at the margin line as we are trying to do this fast integration. So it's the two dynamics -- one is restructuring our automotive operations that Pam talked about, and then adding all these sales -- was not positive, but not a lot of margin to date. That's what we try to do and then get them up to the Parker standards later.

Just as a clarification -- so was there restructuring in the quarter at CIC, or no restructuring? I thought Pam said there wasn't any.

No. A nominal amount. A nominal amount. There was some larger earlier in the year, and we're just now starting to see some of the benefits of doing that.

The bulk of the restructuring is in the first and second quarters.

I guess maybe a follow-up. Do you happen to have cash taxes handy for the quarter?

I'm sorry, say again?

Do you happen to have cash taxes paid in the quarter?

No, I do not. Sorry.

I will follow up. Thank you very much.

Alex Blanton, Ingalls & Snyder.

Ingalls & Snyder. Your incremental margins were very, very good in the quarter. By my calculation, in North America, and we are talking operating margin here -- 32.3% incremental.

Wow, you are good.

It is you. International was 23.8%, and aerospace was 19.6%, and overall, segment operating income was 22.9% incremental.

Right. That's [multiple speakers], Alex.

You had a quarter in which raw material costs were going up, steel costs were going up, copper was going up, and other companies were experiencing shortages and delays that were causing inefficiencies in operations. Yet you've had a tremendous increase year over year in your operating margins. Could you just briefly tell us why you have been able to execute so well?

Well, Alex, I think it starts with customer service, okay? First of all, we've been really focused on, as you know, as part of the Win Strategy on customer service, we've been really doing a great job. I have to say everywhere around the world now, when I get the reports, everyone is really doing a wonderful job on customer service. That is the first and most important thing that we have to be working on.

Where the margins come from is the continual, ongoing, focused execution of the Win Strategy. We've been talking about it for five years. We have been executing on it for five years. We have not taken our eye off the ball. We have been working the strategic procurement side of it, we've been working strategic pricing, we've been working the lean initiative. We're taking lean to a whole new level in the Corporation.

And all of that is coming to bear on the margins, in spite of the fact that when we bring on -- one of the things that I've been trying to tell the community out there, the financial community, is that keep in mind that when you're looking at an acquisitive company, you can't just look at the margins, even though our margins are tremendous right now, our incrementals are tremendous.

The real offset in the early days of an acquisition is cash flow. So what we would like you to focus on is really both cash flow and the margins. It just so happens that we're doing very well on both sides of the equation. Where our cash flow is tremendous, our margins are very, very strong. Our incrementals are very strong.

And the reason why I say that about acquisitions is because what you end up doing early on is you end up amortizing the intangibles, okay? So we could buy a business that makes 15% operating returns. When we get it and bring it on board, it might be down to 10. So it's hard to keep -- and that could be dragging down the rest of the margin from your underlying business.

The good news is that we've been buying good businesses. We've been executing on fast integration, on all of these initiatives. We've been doing it quickly, quicker than we have in the past. And it's all showing in the results. And it's no more or less than what I just said. It's just a strong execution on all the Win initiatives that we have been working on.

And speaking of cash flow, what's your CapEx as a percent of sales going to be this year? It's going to be lower than usual, right?

Right now, it's around 2.3. What we have said is that -- and I think the last quarter might have been up around three or [multiple speakers]

This is about half of what it usually is, right?

Yes, and again, it's indicative of what we have been working on with our lean initiative. We're buying -- well, first of all, we're not expanding plants by and large. There's a few places around the world where we've had some expansions. And they're primarily in low-cost countries.

But by and large, at this point in the cycle -- in prior cycles, we'd be expanding probably half the plants in the Company so that we could make additional room for additional production. Today, we are not doing that, and the reason being is because we've done such a tremendous job with lean and taking inventory down, which has been taking up a lot of space in a lot of these plants. We have freed up a tremendous amount of plant space. That is the one part of it.

The second part is the way we are configuring our manufacturing platform, our manufacturing floor, if you will, in our plants around the world is in a configuration where we are manufacturing more on a just-in-time mode. So we don't need these huge pieces of equipment that can make a million widgets a week. We need equipment that is flexible, smaller, lower cost, can be put into a flexible cell and it can produce on demand, okay, just-in-time, if you will.

And that is how we are configuring the entire -- all of our manufacturing footprint around the world. And that is what is creating the lower demand for capital. You can see -- this is not the first year of this. We are several years into this recovery. And it continues. And we are pretty -- we are very, very pleased. We thought we could settle in around 3%. We think that longer term, probably 3% is still probably a good number. But by and large, we have been beating that. We budget for 3 and we're coming in much better than that.

Quickly, on the orders, your average, if you take a weighted average, and I noticed you mentioned 6.5% blended rate for March -- if you blend January through March and weight the orders of each segment by the sales for the quarter, it is 9.2% weighted average for the last three months. And if you look at December through February, which may be more indicative of what the quarter's deliveries were, it is 11.6% weighted average for those three months. And then if you average those two three-month periods, you get 10.4.

So that is pretty close to the 10% organic growth that you had talked about. But I think you really should give us a blended rate every month, as well as the individual segments.

Well, we have been talking about that internally here, is that maybe what we should be considering is giving you like a 3/12 -- that would be a blended. That would be the last three months over the prior year three months, and that what kind of give you a rolling 3/12 to try to mute out some of the spikes and the troughs here to make it a little bit smoother. So that is something that we could do. We're talking internally about the possibility of doing that.

Well, I think you should give us the monthly rate, but just give us the average as well as the total for each segment --

[multiple speakers] I understand what you're saying.

Give us the total for the Company as well as the segments, because people tend to look at North America and ignore the rest.

Yes. You are right. Absolutely. I think that is what happened this month.

One final question -- market share. 10% organic is much faster I think than the average of your markets are growing. So what is happening with your market share?

Alex, this is Tim. I think that -- actually, it's very -- I think it's extremely difficult for us to tell you that today. In other words, we know our numbers as of today. But most of the so-called market data doesn't come out for six to eight weeks later. So it is always interesting to me when people tell you that.

So I think that clearly, as you say, the 10% is a very, very strong rate. And if you look at the indicators that have been coming out, that's above that. So I think clearly that having the premier customer service, having the best lead times, having the breadth of the product, having all those other things certainly is winning us new business.

David Raso, Citigroup.

Looking at the strength of the industrial margins, can you help break out for us the OEM growth versus the distribution growth in North America this quarter, and maybe also some insight on price versus cost?

David, this is Tim. I would say that it's fairly typical this deep into the expansion, the OE growth -- as Don mentioned earlier, the distribution growth is doing quite well, a nice solid double digit. OE growth, depending on who you're talking about, which market, probably aren't at those -- still kind of those levels. So I would say at this point in time, distribution is doing a little better than the OE. And by implication on that, we do a little better margin with the distribution than we do the OE.

And the second question on price versus cost for the quarter -- do you have any sense for raw material costs year over year versus price increases?

Yes, we have, as you know, with strategic pricing, and we track that and very closely. I'd say we're doing a good job keeping it in balance. There isn't any opportunities at this stage to get out ahead of anything. But you also don't want to fall behind. So I think we're doing a good job of passing things through. And I would say we are keeping pretty much in balance.

The real challenge now has been in really two areas as far as materials. It's been in aluminum and in copper. And those have been really going vertical on us. And of course, you're never quite caught up because they continue to move. So the faster you move and trying to get surcharges and whatever, the next time you look, the materials have moved again.

So steel and some of these other commodities have flattened out somewhat, muted a little bit, but really it's those two areas that still are problematic. And yes, we're doing our best we can. You're never in real time; you're always lagging a little bit. But by and large, we're doing the surcharges, and in some cases we have contracts where we have escalation clauses in the contracts, and we're exercising those clauses for raw material increases and doing the best we can. But I think by and large, we're doing a pretty good job of it, yes.

And on the SG&A spike for the quarter, Pam referred to the compensation aspect of it. If your SG&A had grown more in line with sales, it would have added $0.12, $0.13 for the quarter. How much was the SG&A overshoot this quarter, somewhat one-time in nature? So thinking for the fourth quarter.

Good question, David. I'm glad you came back on that because there really is two ingredients -- two components to that. And actually, we did not touch upon the larger of the two. There's certainly, with the stock hitting an all-time high, caused us to do some adjustments on accruals and so forth so much as geared to the stock price.

A much bigger phenomenon for them, but it is an opportunity for us, is that the acquisitions are coming in to us with a much higher SG&A rate than we carry. So I did a lot of an analytics on this thing. And Parker traditionally runs in the 10 to 11% in that SG&A category. And the acquisitions that we have made here, and we have made several big ones this year, actually came in at more like 15 to 16% on their SG&A line.

Now, this is not unusual that the smaller companies would have a higher expense on those items because they are smaller. And this is where we have a lot of opportunities to bring them into the fold and make some nice changes. We can do a lot of back-office stuff in terms of providing accounting services and just getting things for them a lot less. Their insurance costs go down; we eliminate a lot of other -- and so forth.

So a long-winded answer, but I took out the acquisitions because I can see them in total -- who were running around 15, 16. And when I take that back out, the Parker rate is up a couple of tenths -- down -- it went from maybe like 10.6 to 10.8. And that would have been the incentive pay accruals.

I suspect, Tim, historically the international business is going to have the higher SG&A. Obviously, domnick came in kind of mid-quarter last quarter [multiple speakers] international. Is that the SG&A opportunity at domnick?

You're absolutely right. And again, that points it out and it points out what a problem in Europe has been for us for a long, long time. If we looked at the gross margin levels in Europe, even the manufacturing margin, very comparable to North America. There's a big difference between U.S. and North America. U.S. and Europe for us was again in the overhead, in the SG&A. And that's why some of the wonderful new initiatives Jack Myslenski is doing are really showing some great payoffs, some great benefits. And so these guys weren't any typical than other Europeans -- yes, a heavier SG&A overhead.

And some quick on the share repo -- we're still looking at net activity there actually a source of funds, you're not yet net out buying back more stock than you're issuing. Can you update us, given especially where the balance sheet is right now? When do we get the share repo, or is acquisitions still clearly the number one priority, even looking out the next two or three quarters?

Yes, David, as you know, we've gone from a 10 million to 20 million authorization now by the Board. That was approved about a quarter back, where we moved the share buyback from 10 to 20 million as far as authorization goes. And we have reloaded the number of shares we can buy back.

So what we have done here is we are looking at share repurchase. Obviously, we're doing some all the time. We are looking at a lot of acquisitions. You may recall a year ago, when I was getting a lot of questions on this as well, I said the one problem that I have is I can't show you what I am looking at. And you're just going to have to trust me that what I'm looking at -- but you can see what I was looking at a year ago because you saw in the first quarter of this fiscal year, we bought $700 million worth of businesses, about 10 or 12 businesses.

That's what I was referring to a year ago that we were looking at a lot. I didn't know how many of those that we could get to the finish line or not. But in fact, we get quite a few of those -- all of the ones that, of course, to the finish line that we were working on at the time.

So I just have to say at this point we're also looking at a number of opportunities and we're going to always keep a balance. We're looking at dividends again. We're trying to make sure that we are maintaining close parity with our peer group on dividends. Obviously, the CapEx has not been a major issue for us as far as investing in our business. That's going to be another focus for us and has been, and we are in good shape there.

So it really comes down to acquisitions, share repurchases and other opportunistic opportunities that we might have for the application of that cash. And all within -- what our goal has been is always to maintain that up to the 37% debt limit that we set for ourselves. So I think, yes, we will be constantly looking at all those factors. But there are opportunities that we are looking at right now.

Jamie Cook, Credit Suisse.

Most of my questions have been answered. First, quickly, Pam, was there any currency impact on EPS during the quarter?

Yes. I really don't know what it is for the quarter, Jamie, but year to date it is about 5 -- 5 million.

And then just quickly back on the CIC margins, you talked about following up on an earlier questions the reasons for the margin deterioration was realizing savings a little later than you expected in acquisitions. I'm just trying to get a feel for when margins start to I guess normalize. Does this end in 2006, or do we continue to see these type of margins in '07?

I think we are hopeful is that we are going to be giving a forecast in a few months on '07. But our plans, at least at this point, is that these should continually improve going forward. And we'll give you more color on that as we give you the forecast for next year.

But could you quantify between the acquisition or realizing savings slower? Was that about half, or was one weighted more towards the other, I guess?

That's a good question. I don't know that --

We don't have breakdowns, Jamie.

I don't -- do you want to take a guess at that? I don't even guess as to what it is because I just don't have those numbers in front of me.

Joel Tiss, Lehman Brothers.

Just the first one -- can you give us a sense of -- it seems like you're being a little conservative in aerospace and you imply mid-single-digit growth in the fourth quarter. And I just wondered if anything structural is going on there.

No, Joel, nothing structural. I think that they -- as you say, the order lead times are great. But in most of that stuff, they're very long -- as you know, it's 12 months out and more. So they are -- and what we are enjoying a lot of here recently is strength on the commercial OE side.

So we are getting good volume. The margins have dropped a little bit. This is all exactly as we told you it would unfold over the course of the year. So I would say they are very, very much to plan. We are seeing a little bit pickup recently here in the MRO side of the commercial. So that is good. That could bode well. And that can come through a little more quickly. Everything else in Aerospace takes about 12 months, but it's the commercial aftermarket that turns around a little more quickly. But I think it's pretty much on track.

And Joel, just to clarify, you said mid-single digits. The implied rate is higher than that. It is high single digits. So I think we have a little bit different number.

And just because almost everything else has been answered, can you give us a little sense of what you're seeing on the domnick hunter, and then you're in sort of the middle of you fast integration here. And inventory levels -- you already spoke about the costs a little bit, so some of the product lines that they have, etc.? Thank you.

Well, first of all, as far as domnick hunter is concerned, it has been a very, very good acquisition for us. We're early days as far as moving forward on all the integration, although there's a lot of integration going on. We've got the entire team focused on the Win initiatives. That was one of the early things that we did at domnick hunter to focus them on that.

We've got the sales organization pretty much aligned now with our sales organization, our filtration sales organization that has been in place. And some real interesting products that they do have -- I think we will talk more about this nuclear biological filtration business as we go forward. That was not something that we talked a lot about early on or not something that we put a lot of value on early on. But I think as we're learning more about this business, the more we like it and like what we see.

But again, it's early to really talk much more in depth on that at this point. The performance of domnick hunter has met our expectation or exceeded our expectation. We are on or ahead of plan as to what we expected to be with the business. The growth numbers are looking real strong. So we are very, very pleased with that acquisition and what's happened and I think there's going to be a lot more good things to come out of it that we can share with you in the future.

Joel, this is Tim. This is unaudited and we don't normally go down into this level, but I was told that domnick hunter had an all-time record in orders in the month of March. So from that perspective, the business is doing real well.

[Alan Strong, Ford.]

Good quarter. Just curious, what was the price overall on your top line for the quarter?

We are thinking maybe a couple percent, Alan.

And what do you expect that to be over the next 12 months?

I don't know if you get much more than that.

I think it is going to vary depending on what happens with these commodity prices going forward. I think it is too hard to judge. We're trying to stay current with what is happening on the raw materials side. As you know, what we do either in January or in July is we have increases at our distribution pretty much globally, worldwide. And that varies by product line.

The reason why it's hard to give you a number is that we're talking 600 to 1000 different line items in a lot of locations around the world. It's hard to average all that. But I'm kind of giving you just a little bit of color on it. Typical increases would be in the 3% range at the distribution level. Now, some products could get hit much higher than that, depending on their content of copper, aluminum and other materials that have gone up. So it really varies. But I would expect going forward, if things continue, probably somewhat in the same range, is what we're talking about now.

Thanks. Good job.

Scott Macke, Robert W. Baird.

I just wanted a quick follow-up on the Climate and Industrial Controls and the restructuring. Can you remind us what you've spent on the restructuring year to date?

I think it's just a little over 3 million.

And over what sort of time would you expect that to get that paid back, or to realize the benefits?

Well, usually we target on one year -- over about a one-year period would be a payback. Was that the number you had?

Thank you, that's helpful. And I know you obviously don't have fiscal year '07 guidance, probably don't want to do that on this call with respect to Aerospace. But just in terms of thinking -- in '07 and given the longer lead times in that business, are you thinking more of a lower-single-digit growth rate? Is the bias more towards an upper-single-digit growth rate?

And then the second half of that question would be in terms of margin expansion, going back to '05, then saw about 100 basis points or more of margin expansion. This year it looks flat to down a little bit. In '07, what would be the early read in terms of potential for margin expansion in that segment?

We would really like to answer your question, but we're really not prepared at this time to really answer questions on fiscal year 2007. We are in the middle of our planning period and will be better prepared to talk about that next quarter.

I look forward to it.

Jeff Hammond, KeyBanc Capital Markets.

Just a quick follow-up on CIC. Is Sporlan specifically meeting your expectations? And if you look at the strength in the HVAC markets that they sell into, in this 13 SEER transition, are you seeing pretty good underlying operating leverage from that strengthened demand?

Yes, I would have to say that Sporlan is. We've looked at some recent updates on Sporlan and how we're doing there. And it is meeting our expectations and our projections that we had. Keep in mind, again, that we had the same impact on margins there as we do everywhere else because of the intangible amortization, okay? So you buy something with one margin and you write off the intangibles and you've got some lower margin impact.

But when you back all that out, yes, we've looked at that recently. We like what we're seeing, and it's growing. It's growing at actually a faster rate than what we had in our BCF for the Board proposal when we got approval on it. And yes, they are picking up obviously some additional demand because of the SEER situation. So all things are doing well. Everything is doing well at Sporlan.

And then if we look 12, 18 months out and you get some of this disruption out of the way and these recent acquisitions integrated, what should be then normalized margin for the CIC segment?

Jeff, I think we have the same goal in Climate and Industrial Controls that we have in the other segments. I mean, we hope to get this business up to a 15% margin, just like we hope to get the rest of the segments up there. We think we can do it. It's going to take us a little time, but we think we can do it.

(OPERATOR INSTRUCTIONS). Robert LaGaipa, CIBC World Markets.

Just a few questions. One, I just wanted to circle back to the implied guidance for the fourth quarter. Obviously, you saw exceptional strength and some strong margin growth across most of your segments in the third quarter, in the March quarter. But usually, from a seasonal perspective, the June quarter is much better. And if I were to go back, over time, the last time you actually saw weaker performance in the June quarter versus the March quarter was back in fiscal '02.

Now is this just -- are you being a little bit conservative moving out into next quarter? Obviously, there is exceptional strength in the U.S. economy in the March quarter -- a rebound from the weak December quarter. Do you have any sense of how much strength in the March quarter kind of took away or muted the seasonal benefit possibly in June? Again, in your opinion, are you being a bit conservative in terms of the forecast for next quarter, especially given the fact that earlier in the call you had mentioned the shift from the OEM business becoming possibly a little bit smaller, the distribution becoming a little bit larger. And obviously, distribution has different -- probably shorter lead times than the OEM business.

Yes, the fourth quarter, actually, now that you have nine months actual and you have our yearly range, our total-year range, you can back into -- there is a possibility that, depending on where we are in that range, that the fourth quarter could be better than the third quarter. I mean, it is certainly in the numbers if you do the math. So that is definitely a possibility and that's the reason why that range exists.

We average about six weeks of orders. So we think we are doing a pretty good job trying to forecast this a year ahead. And actually, like last year, you may remember that there was a lot of concern last year about this same time about where we were going to come out. We went out at the beginning of the year with a $4.50 EPS number and after all the gyrations in the last year, lo and behold, we came out at $4.55. So we were within a nickel of where we started with. I think we are going to be hopefully as accurate this time around. That is really our intent.

So we think that the two quarters will be fairly similar. Remember what Tim said earlier, is that you do have three less days -- you've got two less days in Europe, one less day in North America that we have to contend with, too, as far as shipping days. So that does have an impact as well.

Can you give us some sense for what is baked in from an economic perspective into the forecast just in terms of what your expectations are, both in the U.S. and also Europe?

Well, right now I'd say -- and again, we're only talking about the next quarter and we're kind of three months, and we're halfway through that -- I mean, basically status quo. We are in the throes of -- we don't see anything happening here in the next three months to change anything now. We've got all our groups doing a bottoms-up and rolling up and gathering all of our economic data and everything else from all around the world. And we will be hearing that story in about a month or so, month and a half. So anyway, all we know is the next quarter. And the next quarter is pretty much status quo.

Just two other quick questions. One is just from an integration perspective, obviously you've made a number of acquisitions and have been very aggressive in that area. Do you have some sense of -- and I know you also mentioned that the domnick hunter integration is going exceptionally well. Do you have some sense of what the acquisition impact is, just in terms of your margins, say, this year versus last year?

Well, we do track that. I mean, we can break that out and track it. And so we know exactly how every acquisition is performing against the plan that was submitted. And we do track that along. And again, all I can say is without getting into the minutiae that they are hitting the projected numbers.

Now Don had indicated earlier we know that in this environment right now, they will come in and immediately be penalized maybe 4 or 5% of sales because that's going to be their amortization of their intangibles. So it is a non-cash item. But right away, the P&L will probably take a hit of 4 to 5%. But they are pretty much performing to form. No problem.

But in aggregate, can you kind of give us a ballpark of what the impact has been? Has it been 100 basis points? Has it been 50 basis points? Just maybe put that into perspective?

Well in the ballpark, again, as I said, we talked about this on another quarter. But in a ballpark, they are kind of in the high single digits. That is with the penalty factor, with the amortization of intangibles.

You're talking about in aggregate, the acquisitions overall are in the high-single-digit percentage operating margin?

Correct.

Last question just with regard to the interest expense moving up, given the lower debt levels, can you just possibly comment on that?

Why it moved up with the lower debt levels?

Exactly.

It's just a function of the interest rate moving up. We have a lot of commercial paper outstanding and with the acquisitions we did, so it's really just a function of that.

That's what I thought. Just wanted to follow up.

But I would point out, if you do not pick up on it, that we actually -- the quarter was so darn strong, especially on cash flow, we did retire $200 million worth of debt this quarter.

I think we will take one more question at this time.

Ana Recinos, UBS.

It's actually David Bleustein. Just a quick question.

Wow, David, that's --

Look what I've got to do to get a question in there. Here's the question -- I know Gary asked about the April activity versus March. And if I look back, Tim, I think the zero month may have been April of last year.

Correct.

So leaving comps aside, is the activity level in April roughly the same as the activity level in March? Pam, is that where you were driving with that response?

Let me answer this again. Let me try and answer this again. I'm very hesitant to say anything about April orders because we are not done and you never know. I just don't like talking about it beforehand. But what I will tell you is that April orders are coming in strong, okay, versus March. We will see what happens. March had a lot of days in it, which you well know. April only has 19 working days. So I will leave it at that. But I think that's enough information to answer your question. Agreed?

Yes, I was just trying to drive it -- forget the actual level of orders. What I'm really asking about is activity level. Activity levels in January and February were very, very strong. March was what March was. Is April more like January/February, or is April more like March? Not year-over-year comparison orders, but just in terms of the pace of activity.

Right.

Yes, I would say that pace of activity is -- we didn't notice much of a fall-off in March, and it still was a positive year-over-year -- just had a lot of workdays. But I guess what we are saying here, David, is I guess if we close the month today and we put the orders out, you'd probably see numbers that were more close to January/February than you would have in March.

And again, you can get the history. We go through these periods. There's no question that we are in a period of increasing at a decreasing rate. That is just reality. We all knew that was coming. But it still also means that we're running at very, very healthy levels. So anyways, but we will see. I know Pam is hesitant, because I am too. I have been shocked and surprise. You go halfway through a month and it looks great, and at the end of the month it all changes on you. So that is why we are trying to be careful here.

Well, congrats on the quarter.

We thank you for joining us today. And of course, I will be around to answer questions. Don just has a few closing comments before we close, and again, I thank you for participating.

Just a couple of additional points. I think we've covered pretty much everything that we wanted to cover with you today. I want to thank you for your time and for the questions that you asked. I think that it should be apparent to you that we are generating the record results that we are as a result of the execution of our Win Strategy. This is an ongoing effort and it is going to continue pretty much forever, at least as long as I am around. I guess that's not forever, but it is going to be a while yet.

We are going to continue to remain focused on return on invested capital. That's what we have been focused on all along. And we want to maintain our position in the top quartile of our peers. We will talk about that every time we meet.

And lastly, I think what we are doing is what we said we would do. We have been talking about what we were going to do as to the performance of the Company over the last four or five years. And the message has not changed. Our focus hasn't changed. We do what we say we will do. And I think that has proven itself out in the numbers.

We talked about acquisitions. And the acquisitions are doing well. And they are accretive and they are meeting our expectations. And we are very, very please with what we have been able to bring on board. It's making the Company a stronger company overall.

And in line with our plans, we did have a great third quarter, and we're looking to repeat that. So we're looking for a fourth quarter that's going to be as good as the third quarter we just finished. And we'll look forward to bringing you up to speed on the forecast for the coming year at the end of this fiscal.

So with that, I will just say thank you and thanks for your participation.

Thank you. This concludes today's third-quarter 2006 earnings release conference call. You may now disconnect.