派克漢尼汾 (PH) 2007 Q3 法說會逐字稿

Good morning. My name is Tamara, and I will be your conference operator today. At this time I would like to welcome everyone to the third quarter 2007 earnings release teleconference. (OPERATOR INSTRUCTIONS) Thank you.

Ms. Huggins, you may begin your conference.

Thanks, Tamara. Good morning. This is Pam Huggins speaking. I would like to welcome you to Parker-Hannifin's third quarter 2007 earnings release teleconference. Joining me today is Chairman, President, and Chief Executive Officer Don Washkewicz; and Executive Vice President and Chief Financial Officer Tim Pistell. Prior to proceeding to the earnings release, just let me take care of a few administrative matters. First, as is customary, I would like to call your attention to the second slide which is the Safe Harbor disclosure on forward-looking statements and ask once again that if you haven't read it, that you do so in its entirety at your leisure. Second, moving to the third slide, this slide indicates that in some cases we've used non-GAAP numbers in order to provide meaningful comparisons from period to period, and these non-GAAP numbers have been reconciled to the appropriate GAAP numbers where applicable. Moving to the next slide, first of all, for those of you that are online, you may view the slides as they're being presented. For those of you not online, the slides will be posted on the IR portion of Parker's website at phstock.com.

With that out of the way, the administrative items, let's move to the agenda on slide 4. Once again, the call will be in four parts today. First, Don -- the Chairman, President and Chief Executive Officer -- will provide highlights for the quarter. Second, I will provide a detailed review including key performance measures of the quarter concluding with the updated outlook for fiscal year 2007. The third part of the call again will consist of our standard Q&A, and once again, please limit your questions to one at a time. We want to give everyone a chance to participate. For the fourth part of the call today, Don Washkewicz will wrap up with some closing comments. At this time, I would like to turn it over to Don. Thank you.

Thanks, Pam. Good morning to everybody on the call. Just a few comments before Pam returns for a more detailed review of the third quarter. First of all, we're certainly very pleased that we're able to deliver another record quarter in fiscal '07, and we certainly expect a strong fourth quarter as well. We're on track for another record year at Parker, a record in sales and earnings, certainly delivering very strong cash flows and record EPS. So on top of the last couple years, which were records, we're really pleased with how this year is developing. We've been saying for quite some time now that we have less exposure to the different phases of the economic cycle than we've had in the past, and I think this is evident in our results. The company today has better global balance in sales revenues and margins than ever in the history of the company. I want to thank our entire global team for continued execution of our Win Strategy. For those that are not familiar with the Win Strategy, it is really what we're doing internally here to drive operational excellence and growth throughout the company.

Just a couple of key highlights for the quarter. We set another new record for quarterly sales at $2.8 billion, and now we're running it at that $10 billion plus pace, so it will be exciting to go add that extra digit this year to the sales revenues. Our growth was 11.3%, certainly ahead of our target of 10, and that by the way is in excess of a 20-year record now where we have a compound growth rate of in excess of 10%. We're certainly very pleased with our organic growth rate in the quarter coming at nearly 5% given the situation out in the economy today, certainly in North America. We're also very pleased to demonstrate continued strong earnings growth. Fully diluted earnings per share increased over 22% compared to a year ago. And we also reduced inventory incidentally about $52 million in the quarter. And I think everyone realizes when you're reducing inventory, you're not absorbing as much overhead in your plans, so having these kind of results with that inventory reduction I think is worth noting. Just a comment on our international segment. Our international industrial segment has again increased its ROS coming in at almost 14% for the quarter, and that now compares to about the same ROS -- around 14% -- for our industrial North American segment. For those that have been following the company for some time, I think you will agree we've never done this ever in the history of the company. We continue to build on those margins going forward.

Our cash flow certainly is strong, and it has enabled us to repurchase over 5.2 million shares in the first nine months of fiscal 2007, so we took advantage of that. Year-to-date cash flow from operations remains strong at about $537 million, which includes about $161 million in discretionary pension contributions, and that all of our results and what we have seen in our markets gives us certainly confidence for another great year in fiscal 2008 and certainly going through this fourth quarter. Just a couple comments on the markets -- distribution remains strong, and I think you should remember that this represents about half of our industrial business is our distribution business. That's still doing very well. North American OEM markets are moderating as expected, and we've been talking about that for the last several quarters. Our international industrial segment is now nearly of equal size in margins compared to our industrial North American segment with trends looking strong for the future. That is something that we've never had in the past. As you will recall, international margins always were maybe approximately half what they were in North America. So we're in a much, much different situation today than we ever have been in the past. The only last thing I would just call to your attention is that we have about two months of visibility in industrial backlog, and about one year in Aerospace backlog. With that, I will turn it back over to Pam.

Thanks, Don. At this time I'll ask that you please turn to the seventh slide beginning with earnings per share from continuing operations. As you can see, we did $1.78 for the quarter, and this compares to $1.46 for the same quarter a year ago. However, I just to want call your attention to the fact that in the $1.78 there is $0.05 gain related to the sale of a real estate, and then last year there is a $0.03 gain related to the settlement of litigation. If you back that out, you're comparing the $1.73 for this quarter versus $1.43 for the same quarter a year ago, a 21% improvement. Moving to slide 8, so what were the components of the strong earnings growth on a consolidated reporting basis in the quarter? Well, first of all as Don mentioned, sales increased 11%. This was mostly led by international and aerospace. They had revenue increases of 32% and 12% respectively. The growth profit increased 13%, again led by the international and aerospace segments with increases in operating income of 42% and 22% respectively. Again, proof that the Win Strategy is working. On higher other income -- we had higher other income as a result of gain on sale of the real estate that we just mentioned. This is the $0.05 gain that was mentioned in the press release, and then of course we had higher share repurchases in the year. However, offset to that, we had some higher interest expense in connection with with commercial paper outstanding, and higher taxes. However, it should be noted that we had a lower tax rate, but it was offset by higher earnings.

Moving to slide 9, looking at the financial highlights for the quarter for the total company, you can see on the top line again sales -- as we mentioned a couple times here, they were up 11%, moving sales to $2.8 billion from $2.5 billion. Of this 11% sales growth, 4% was the result of acquisitions, 2% the result of currency, mainly the Euro, and we had 5% organic growth in the quarter which we're quite proud of. Moving to slide 10, the strong double-digit sales growth in the quarter was the result of obviously continued strength in Europe -- particularly Germany, Asia Pacific remained strong. Latin America while soft historically is showing improvement, particularly in Farm and Ag. Acquisitions continue to contribute, distribution continues to do well, and the robust levels continue to be seen in the commercial side of the aerospace business.

Moving to slide 11, segment reporting in income from operations starting with the industrial segment and specifically North America, you can see that total sales decreased in the quarter 1%. Acquisitions added 2% to revenues, currency had little impact, and of course base sales were down 3% in line with our expectations. Most significant on this slide is that on a sales decline of 3%, operating income decreased 11% for the quarter versus the same quarter year ago, moving margins from 15.5 to 14%. The reason for this is twofold. First of all, we had large inventory reductions in the quarter, and secondly, due to acquisitions.

Moving to slide 12, continuing with the industrial segment moving to international, here you can see that sales increased 32%, and of this 32%, 9% came from acquisitions, 9% came from foreign exchange, and then of course base sales grew internationally 13%. Operating income in the segment was 41% higher than the same quarter last year, and you can see we had 100-basis point improvement in the margins, going from 12.8 to 13.8. International continues to do well across various markets with strength expected to continue in the foreseeable future. Also aiding this segment is the acquisition strategy. Of course the one phase to the customer initiative that we talked about, success of the win initiatives, and of course revenue. We're putting more product through the current facilities.

Moving to the next slide, 13, Aerospace -- here, operating income for the quarter is 22% higher on a 12% increase in sales. And this increase in operating income is the result of higher commercial OEM volume that we've been talking about, and of course a higher mix of after-market business. The increase in operating income -- this is in spite of a macro shift to commercial OEM business which carries a lower margin, new product win development costs, and lower defense spares business. The higher aerospace margin of 15.2% -- that's 130-basis point increase from 13.9% a year ago. Moving to slide 14, Climate Industrial Control segment -- here you can see that total sales increased 3% in the quarter, but operating income decreased 21% versus the same quarter a year ago. Base sales, however, grew 3% in the quarter, and the acquisition growth of 2% was the offset by the currency, as currency decreased sales in the quarter. Margins decreased to 6.9 from 8.8%, and again the reason for this decrease is due to the large inventory reductions in the quarter.

Moving to orders, you can see our recent order trends on the slide before you. I think these orders provide further confirmation of the expected strength in sales as we move towards the end of the fiscal year. As you know, orders are stated as a percentage increase over the prior year without acquisitions and currency. And again orders through Parker's distribution channels continue to be strong. And as you know, Parker serves 1,200 markets, which helps mitigate any volatility in specific sectors. Orders continue to increase year-over-year, and this is on top of extremely high comparables going back to the latter half of 2004. While North America has moderated, orders in industrial/international -- they continue to grow at high levels as evidenced by the 15% growth in March. International strength is supported by growth in Asia, Latin America is showing improvement, and again Europe remains strong. Aerospace, OEM, and MRO continue to be strong on the commercial side. Remember, however, that aerospace -- due to the volatility from month to month -- is reported on a 12-month rolling average. In the Climate Industrial Control segment the order strength as anticipated has moderated, but you have to remember that's due to SEER, the Seasonal Energy Efficiency Ratings, so the comparables were extremely high as a result of the prebuys in that area.

Moving to the balance sheet -- as you know, our balance sheet remains solid. Cash on the balance sheet at quarter end was $184 million. Commercial paper outstanding was very low at $84 million. Inventory in terms of DSI is 64, down seven days from December. However, accounts receivable in terms of DSO is up one day coming in at 50 days versus 49 days in December.

Slide 17, addressing cash flow -- as Don said, after making $161 million contribution to the pension plan, operating cash flow for the nine months ended March was $537 million. Of this $537 million, we spent $175 million for CapEx, which represents 2.2% of sales. Acquisitions consumed $188 million, and share repurchases cost $413 million. As a result of this and more, debt increased by $278 million since June. However, on slide 18 you can see that the debt to total cap ratio is 23.8%, and on a net basis 21.3%.

I will now address the updated guidance for fiscal year 2007 that's shown on slides 19 through 21. On slide 19, you can see the guidance by segment for sales and operating margin. As I would like to save time for Q&A, I am not going to recite the guidance details by segment. Slide 20 details the guidance for the items below segment operating income. In summary, though, on slide 21, the guidance on an earnings per share basis from continuing operations is $6.80 to $7.00. This is an increase from the previous guidance of $6.35 to $6.75. Please remember that the forecast excludes any acquisitions that may be made moving forward in fiscal year 2007. Fiscal year 2007 segment operating margins are expected to be higher than fiscal year 2006. At this time, I would like to open the call for questions, and after the Q & A, I'll turn the call over to Don, who has a few closing comments.

(OPERATOR INSTRUCTIONS) Your first question comes from Jeffrey Hammond with Keybanc Capital.

Hi. Good afternoon.

Good morning, Jeff.

It has been a busy day already. If you could just give a little more color on the margins in industrial North America -- how your inventory reduction and these acquisitions are impacting that and how you're looking at -- in a softer slightly down environment, how we should look at margins on a go-forward basis for the North America segment?

Well, first of all, we said that we introduced inventory by about $52 million. You can see in the first half of the year we increased inventory, and this is pretty common within our cycle. However, the dollar amounts are pretty large this time. We had some incidents where SEER 13 -- obviously we built some inventory in connection with that, the ramp-up in international. And so we look at it as you're reducing that inventory you're not getting absorption. It is usually about $0.30 on the dollar. That's what happened in North America. There were big reductions. Out of the $52 million, the majority was in North America.

Okay. As you talk to your OEM customers in North America, are you getting a sense that this is bracing for more notable slowdown or is it just some inventory correction that may not persist on the longer-term basis?

This is Tim. I think that in talking to the marketing guys, I think that we still have a ways to go. I think the North American automotive -- that inventory is coming in line. I think we may have a little more to go on that. The heavy truck is really going to be -- I think is really going to be much softer now in the next quarter coming. We saw the downturn in this quarter begin, but it is going to be much softer there. I think that the residential construction is a little problematic as well right now, but those would be the three, Jeff. I think everything else is stable to up, and I would say fairly positive coming back from the marketing people. So I just want to clarify on the inventories as Pam mentioned -- we built in the first half. That was a plus. It always is. We did that to meet customer demand with the customer demands backing off. We are now reducing, and the $50 million that occurred about I think $30 million of that $50 million occurred in the North American industrial, and about $15 million occurred in the CIC, so those were two big chunks of that inventory reduction and there definitely is economic impact in the quarter that occurs.

Okay. That's helpful. Thanks.

Your next question comes from [Chase Becker] with Credit Suisse.

Good morning. It is Chase Becker for Jamie Cook today.

Good morning.

Just had a quick question regarding your outlook. If you back back into your fourth quarter, you're basically saying that you're going to be on par roughly with the third quarter. And just using that math, that would put you at the high end of your current guidance range. Am I looking at that correctly? Is there something else that I am missing or is this just conservatism?

No. I think when you look at North America, when you look at the second half, we're kind of saying that fourth quarter is going to be very similar to third quarter. We did $1.78 first quarter, and you take out that $0.05, you get $1.73. We're saying that we think that the last quarter is going to be similar to the third quarter.

Okay. And then my follow-up is -- do you have a figure in terms of how currency impacted profitability?

Yeah, I do. Negative $2 million.

Okay. Great. Thank you very much.

Your next question comes from Robert LaGaipa with CIBC World Markets.

Hi, it's Bob Lagaipa. Good morning. Difficult last name. A couple questions. One, on Aerospace. The implied guidance there for the fourth quarter implies that Aerospace sales actually going to be down a bit from the third quarter. Can you just walk us through what's the reason for that?

Sure. We've been talking about for some time, Bob, remember that in Aerospace there is an ending of the spares orders on the military side.

Sure.

Okay. Now, while we're still getting repair and overhaul business, this was a big program back in the '90's. There were a lot of spares that were issued out there. They're just not using -- there is a lot of inventory out there with the Army. And so as a result we're getting volume on the R&O side of it, but we're not getting the volume -- the spares continuing to ramp down, and it will end by the end of the year.

Okay. So it is entirely the completion of the spares contract.

It is pretty much that defense is flattening out. It is remaining at a high level, but it is flattening out, and commercial OEMs still continues to be robust.

Terrific. Two other quick questions if I could. Obviously the sales were a bit better in the third quarter -- that the third quarter just reported, and I am just trying to get a sense for -- if you look across the segments in terms of the guidance, and obviously you've raised the sales expectations across the segments. I just wanted to get a sense for how much of that is acquisition related? Specifically, I guess in North America and the international business?

Yeah. Actually, from the North American side, it is pretty minimal. A little bit higher on the international side. If you look at acquisitions, what we're expecting going out there is about fourth quarter about $114 million, and most of it is international as opposed to North America.

Great. Last question, this one might be for Tim. I am not sure. The other business segment expense -- last quarter it was actually income. This quarter it seemed like you ran below forecasts significantly. What was actually in that number, the $14.8 million? And is that something that's going to jump around from here on out or is it just quite simply something you just can't forecast?

It is a little problematic to forecast it because included in there we do get into some things like LIFO adjustments, and we carry some of the pension adjustments in there. And so it does get a little problematic going out on there, and again any currency. So there is external things that can occur to us that makes it a little tougher to know where things are going to be at the end of the next quarter.

Bob, if you look back, you go a couple years back, pension was really high, and then it reversed. Currency went the opposite direction. There is just a lot of things in there, and then there is unusual one-off type of items that will flow through there as well.

Was there any specific couple items that were fairly large, either from a gain or an expense and more items were gains or how should I think about the $14.8 million?

We had that $0.05 gain from the sale of the real estate that's in there.

Okay.

One other -- I sometimes get confused as to which numbers we're comparing against which. If I am looking at the other expense, are you looking in the segment area?

Exactly.

Yes.

If I am looking at the other expense in the segment area, and I am looking at this quarter, '07 versus this quarter '06, there is a significant improvement. One of the things that did occur there which I want to emphasize really is on the pension side because we carry the amortization of gains and losses there. As we've been saying for several years in a row now, we have been pumping a significant amount of money into the pension plans that were unfunded, and the result of that now has enabled that expense to come way down. So although it is first looks nonoperating expense, it certainly is one that we have been addressing and putting money into, and a big part of that decrease year to year is on that pension side.

Terrific.

Bob, I would just like to say here I think it is important to note that when we compared our guidance to our actual results, we beat the guidance 50% on the segment operating income line, and then of course in the other category as well.

Okay. Thanks very much.

Your next question comes from Andrew Casey with Wachovia Securities.

Good morning, everybody.

Good morning.

Question back on the other line that Bob and Tim and you guys were talking about. The pension adjustments -- if I back out the gains in both periods, the $0.03 last year, the $0.05 this year, it looks like there was about a $0.09 improvement. Is that all the pension stuff, Tim?

There is some pension, and I think -- I am getting some data here from other people. Pam, why don't you -- definitely a big chunk is pension, and the rest is --

There were several things, Andy, in there. And quite frankly to be honest with you, there is $0.01 here, $0.01 there, but there there was a minority interest, there were some insurance proceeds, there was the gain on the sale of the real estate, so there were some things in there that -- a little bit unusual.

Okay. Because one of the reasons for harping on it is if you look at your guidance, the 51 to 54% reduction, I think we're talking about this line. And if you go back and add in all the one-times, which is probably I am guessing how you're looking at it, it implies another $10 million to $15 million year-over-year benefit in Q4 '07. Am I looking at that right, and is it just carrythrough through this?

Yes.

Okay.

The pensions which is a substantial item is why I broke that out is something that we certainly expect to carry forward.

Okay. That's it for me. Thank you.

Thank you.

Your next question comes from Mark Koznarek with Cleveland Research.

Good morning, Mark?

Good morning. On the international side of the business, could you give us some detail about the various geographic regions and some of the vertical market standout areas that helped drive the core revenue growth?

Well, Mark, I would have to say that -- this is Don. When you look outside of North America, first of all, Europe has been very strong. A lot of activity going on near forestry, mining, machine tool, pretty much across the board, everything. I just got back from Europe last week, and I tell you, I have never seen it more positive overall. Very pumped up. The entire sales team was pretty excited. As a matter of fact, I was at the Hanover fair, and that was pretty typical across the board for everyone -- so very, very positive mood and very good outlook for the future. Asia is doing well, still growing very well, and I don't see any let-up there anywhere in Asia as far as that goes, both Korea and China in particular. Latin America we see that that's bottomed out and we see positive moves and some like the Ag and construction and so forth, we see some movement back up in a couple of those areas. So I think all in all -- and then anything to do with oil and gas and mining of course is very positive right now. You know about the Aerospace part of our business and the distribution I already mentioned being very strong. So with the exception of housing here being soft, heavy duty trucks being soft -- you know those segments -- North America, automotive, especially with the big three being soft, and probably a little bit of a delayed rebound on the refrigeration/air conditioning of the business because of the overbuild on the SEER 13 units -- we will have to let that bleed off. And you will see that segment rebound here, too, once we get through this spring period and into the summer months. So that's kind of the way we're looking at it.

Okay. And then as the follow-up, given the balance sheet leverage being relatively low and the cash flow so strong, how should we be thinking about ongoing share repurchase activity from here on out?

We're doing about $20 million a quarter. What we're doing is buying shares to basically offset stock option exercises and so forth, so we'll do that as a matter of routine each quarter. When we go beyond that, we're basically looking at all the other alternatives on the table at that time. We review this in each of the Finance Committee meetings, and that would include as far as acquisition growth, what's on the table there as far as opportunities, and anything else we want to do. For instance, as far as funding innovation internally more new product development like what you're seeing out at Aerospace, all of that is kind of in the mix as to what we do with those funds. Share buyback is certainly one of them. You can see that how we took advantage of the poorest share price that we had for most of the year, and we're able to buy back pretty good number of shares in the first nine months, so we'll continue to look at that.

Okay. Did acquisition contribute any earnings in terms of the properties that you bought within the last twelve months?

Well, Mark, this is Tim. Definitely. We tracked the acquisitions. We track each one of them for quite a long period of time, and as you probably know, that we -- within Parker, if you do an acquisition, you're back in front of the Board of Directors with a make-good report in two years and five years, so we're highly disciplined. Order of magnitude, the acquisitions right now look like there would be running high single digit which would be quite good, and collectively they're running ahead of their first-year plan. You end up having to take a lot of hits in the first year as part of your purchase accounting, but they're definitely positive, high single, and really ahead where of we expected them to be.

Is that even net of noncash like purchase accounting?

Yes.

Okay.

This is all-in, and there are some unique accounting things that have to -- that occur as part of your purchase accounting where you got to write a lot of things up, you might write inventory up, and then in the first quarter you know you have to write it all off as you sell it, so it is -- there is some tough accounting that you have to go through, but that is all in. Acquisitions carry goodwill. They carry the amortization of the intangibles. They carry everything related to that transaction.

Okay. Thank you.

Thank you, Mark.

Your next question comes from Ned Armstrong with FBR and Company.

Good morning, Ned.

Thank you. Good morning. My question regarded acquisitions. You in recent years have specified several areas -- filtration and refrigeration among them -- where you wanted to pursue acquisitions because of favorable market characteristics, et cetera. Are there any additional areas that you've not focused on in the past that are becoming more ripe for acquisition activity?

Well, I would say, Ned, that we're going to stay focused on what we've been doing. This is a pretty large space that we've targeted here in motion and control, and there is so many opportunities here for us to go after that. It really would not be prudent, I wouldn't think, to divert our attention to another area. Now, does that mean that we would never do that, I don't think so. Certainly we're always looking at other opportunities, but there is so much out there right now that we can go after that that's where our focus is going to be, at least in the near term.

Okay. That's within the refrigeration, filtration, and other areas within motion control that you've specified.

Right.

But I was thinking of maybe other areas within motion control that you haven't focused on -- I guess is the angle I was coming from?

Well, you saw what we did. We bought a little sensor company. It is just a nice fit with the rest of our hydraulic and systems package. That is something a little off on a tangent we hadn't done before -- build up our sensing capability so we can give more functionality to the end-user of our equipment, and they're asking for more functionality. You will see those things happen and little technology acquisitions that we have made over the years, and investments like in fuel cells and areas like that, things that support our life science efforts. So there is a lot of little new markets that we're going after -- but more on an investment, not necessarily a big acquisition basis, but we're making investments in these areas and will continue to do that and continue to pursue some of these niche markets.

Okay. I see. With regard to CapEx, you have recently spoken about CapEx being in the neighborhood of 2% of revenues going forward. Is that still the case for '07 and beyond?

That's a good question, Ned. I would say, we're going into our planning period right now, and typically what the groups -- it is a bottom's up forecast we do around here. What the divisions ask for then gets rolled up into the groups and then comes up to corporate. And typically what we've seen in the past is a request for in the neighborhood of 3 to 3.5%, and this is true for probably the last three or four years, and in fact we authorized that. We have discussions with the board, and we make a decision that we would authorize 3, 3.5%, whatever they have asked for to help support that internal growth, and in fact they're only spending, 2, 2.2 and whatever. We're not starving the divisions. We're not starving the groups. We're giving them whatever capital they need, but they're finding ways of doing more by executing on the lean initiatives and so forth to get more output out of the in-place capacity that they have already, and that's good news. I would say going forward we'll see what they come up with next year. It wouldn't surprise me if they ask for 3% again and they don't spend 3%. We around here targeted 3% as a good number, and I think for the long-term if you're trying to model something using 3 would be fine. I don't ever see us going back to the days of old where we spend upwards of 5, 5.5% what we used to do in the past when we were basically manufacturing to inventory as opposed to manufacturing to demand.

Okay. Got it. Thank you very much.

Thank you, Ned.

Your next question comes from Chris Kotowicz with A.G. Edwards.

Good morning.

Good morning, Chris.

On the acquisition front, we touched on that a little bit. Can you throw your $0.02 in as to what the environment looks like? You've been doing some deals this year, but obviously last year you were at a blistering pace, and seems like while there are some deals getting done in the space it kind of feels like the pace overall has slowed down. Is that in your view because the pricing has gone up, the quality of the assets isn't what it used to be or just trying to be patient?

This is Tim speaking. I think it is a couple of things. First of all, as you observed, we did quite a bit last year, almost $1 billion worth that we added in revenue, and that of course created some integration digestion issues. Some of the groups were pretty busy having their hands full doing that. There was a bit of that. Number two, in terms of what we see out there, there is absolutely no question that the multiples have moved up right now, and some properties are getting very pricey, and they sometimes get in a realm where -- we will not acquire anything where we don't see the clear positive return to the shareholders, and so that I would say in some cases has become problematic. Having said all that, we are very busy. We have a lot in the pipeline, and echoing Don's comments here, especially when you go over to the Hanover Fair and you see everyone in the world showing up over there, this is just a huge market with a lot of opportunities. Again, we are staying disciplined, and our long-term goal I would remind is of course the 10% growth, and historically half has come internally, half acquisition, and we fully expect that to continue as we go forward.

Okay. Maybe switching gears. You got double-digit order comps across total Parker over the next six months, so you've got lower inventories today than you might have had given into like the growth level that you put up, you actually backed off as you discussed in your comments. You know, maybe how is business shaping up so far in April, and do you have some concerns in the June and September quarters, just given the comps if nothing else are going to be sort of soft?

I think we've given you our indication of the rest of the year in this guidance. I think we're looking for a very nice finish, a very strong finish, and you see that we narrowed that range down for you, and moved it up. So there is nothing that we are feeling bad about here for the end of this year, and certainly to the extent that we can see beyond that, we see nothing really that I could detect in the international markets that's going to change any time soon. I think the North American markets probably are where they're going to be for the time being, and I think we hit on some specifics with respect to refrigeration probably improving as we get into the summer months. What happens to housing starts, I don't know. I think Latin America is going to improve, so -- and Aerospace as far as we can see, Aerospace is going to be strong. So I would say looking out now, we're going to give you more specific information of course on next year, but looking out beyond the end of this year which is within sight now, I don't see any real black cloud hanging out there, so I think we're pretty bullish. All the inputs that we're getting is positive, and the thing to keep in mind that -- I couldn't say this in the last cycle because in the last go-around, if North America softened a little bit and the rest of the world picked up, we were picking up lower margin business. That's not the case any more. We're in a much, much better position ever than we've ever been in the history of this company to manage through whatever is going to come at us through this period. I think we're very positive. We'll finish the year strong. We'll get into next year, we'll give you more updates on that as we go forward, but just from recent travels, I think we're pretty positive here.

Okay. Thanks. Good quarter, and we'll take the rest of our questions off line.

Thank you.

Your next question comes from Eli Lustgarten with Longbow Securities.

Securities. It's close. Good morning.

Good morning.

Terrific execution. Just one quick question. One, input costs -- you say we're seeing steel, nickel, stainless steel, copper starting to shoot up again. Are you beginning to see any of those pressures on the business and on pricing having to be adjusted? Or any problem adjusting prices for the rising input costs?

The answer to all of that is yes. It has been a challenge, Eli, for a long time here as the raw materials continue to escalate, and I think you hear that big sucking sound coming from China. That's where a lot of this is going. That's what's driving a lot of the demand here, especially in the copper, the brass, and the high nickel alloys. Aluminum to a lesser extent I think we see that leveling out. I think steel has been more moderate of late than what we've seen in the past, but it is the brass and copper and nickel-based alloys that are just really going crazy. What we're doing is the best we can. Of course our customers are getting weary of price increases too, just like what we are. But I tell you what, you're either going to pay the price or you're not going to get the material, and you'll shut down production lines, so you don't have much choice. There is limited supply, currently a lot of demand, especially from Asia, and for the foreseeable future I think that we're just going to have to live with this, do our best to pass these on which we're working on all the time, whether it be in increases or surcharges or whatever, and do the best we can to maintain our margins through it all. We've been doing this I think pretty well. We executed very well. I think you can see that in the past quarters in the last couple years in making sure that we didn't see major margin erosion as a result of this.

Do you have any vehicle what pricing contributed in the quarter corporatewise or domestic and international?

Eli, it is almost impossible for us to tabulate that. Frankly, I think it would be a push at best for all the given reasons. A lot of increases, hard to get those through real quickly, and we do have some typical increases that kick in -- let's say on first of January, first of July. I think at best it was a push. We could actually have been a bit of a drag on it.

Final question. Inventory levels at the distributors, do you have any sense whether they're normal, high, low, what the people are saying, what they're telling you?

Tim, again. In talking to the marking people, I think they're feeling they're balanced. I mean, I think they're fairly balanced to demand.

We should be coming to the end of the inventory liquidation by end of the fiscal year.

The inventory liquidation, let me correct that. That was not occurring as much at the distributor level as it was here. A lot of that was really OE driven where we are direct to those customers, and so it was more Parker than it was out in the distribution channel.

All right. Thank you. Nice quarter.

Thanks, Eli.

Your next question is from Alex Blanton with Ingalls & Snyder.

Good morning. Just a clarification. First, the guidance includes the $0.05 gain in the quarter?

Yes.

The full year guidance includes the $0.05 gain?

That's right.

Okay. Secondly, you mentioned the $52 million inventory reduction quarter over quarter, and that of course leads to underabsorbed burden -- and did I hear you correctly, you said that the pretax effect of that would be 30% of the inventory. Is that correct?

Right.

So that's a usual number. I think with Caterpillar and Deere it's in that range, 25%. But if you use that number, that's about $15.6 million pre-tax, $11 million after tax, and about $0.09. So in effect, the fact that you reduced inventory, lowered your third quarter earnings by $0.09, is that correct? Had you not reduced inventory and everything else stayed the same you would have earned $0.09 more.

Potentially.

Yes. In other words, that's what that 30% indicates.

That's pretty good math.

Okay. Good. Finally, Don, there was a very, very fine article in the Wall Street journal front page on March 27th featuring Parker-Hannifin's pricing policy, "Seeking Perfect Prices, CEO Tears Up the Rules".

I know what everybody was thinking, that was a scandal about to be uncovered there, right when it says tear up the rules. Now we got them.

That's good headline writing, got people to read the article.

Right, right.

My question is this. You were very, very candid in that piece, and it was a very large piece with a lot of detail on your pricing policy and strategy -- strategic pricing that you put in.

Yes.

But it was very candid to the point that I thought most companies would not talk about their pricing policy as openly as Parker did because there might be ramifications with some of the customers once they read this. Have there been any? How did your customers react to this article?

Well, that's a very good question, Alex, and frankly when I was asked about doing this interview on this article on strategic pricing, I had a little pause there about whether this was a good idea or not, but I had pretty good discussions with the reporter and explained the sensitivity to the issue and the fact that things can be misinterpreted if they're not explained properly and so forth. I think the reporter did a great job with a very, very difficult subject to make sure that people didn't think that we were just out there raising prices indiscriminately. If you read the entire article -- if you only read the first page, you're probably left with a bad impression from the article from a customer perspective. If you read the entire article, most of the OEM customers fall in category A on the second page -- the internal page, I forget what page that was on -- and that is that you've got to be market competitive. And there is very little opportunity for real strategic pricing when you're an A item -- a big volume, high volume item sold to OEMs. So if the customers really read the article, they were okay, and we made sure that our salesforce made sure that they understood the various categories that we had broken the customers down into as far as or -- I should say not customers but products -- into as far as opportunities for increase. So really the opportunity that was described pretty clearly in the article was the opportunity from the BCD items, the classics, the specials, things that nobody else wanted to make. That's where most of the opportunity came from, and that's what's most often overlooked in companies because you're off focusing on the big high volume A items and not focusing on the rest of the product offering.

So how did the customers react is really your question, and that was my main concern. Actually we had one slightly negative response from a purchasing manager that came back through to me. We've actually had a competitor that has gone around trying to distort the article to their advantage which I found kind of interesting. But it is a real positive, and I didn't expect this. We had four or five customers now that have called and asked us if we would teach them how to do this. Now, that is frankly something I did not expect to hear, and frankly I am really pleased that we did hear that, and we are going to teach them some of the fundamentals as to how to do this. Obviously we couldn't put everything in the article. There is a lot more there. That's the basics of strategic pricing. There is about seven levels beyond what was printed there, but we will help our customers, and I think that was a real positive response.

Thank you.

By the way, I did get some calls from some other people, too. As a matter of fact, the Harvard business school wanted to do a case study and several other inputs from suppliers and things like that, so we're trying to address all of those as it makes sense.

Thank you.

Thanks, Alex.

Your next question comes from Mark Koznarek with Cleveland Research.

Hi. Thanks for taking the follow-up. As long as Don and Tim, you guys are available on the call here, I wanted to ask about the decision to change the format of orders reporting beginning in fiscal '08. It seems like there is a lot of value in the monthly orders as they're reported for people who take the time to really look carefully at them, and I am kind of disappointed to see that things are changing there. So I am just wondering if you can elaborate on what the new policy is going to be like going forward.

We wanted to give everybody a lot -- this is Don -- we wanted to give everybody a lot of advance notice, and I think we did about six months notice as to the change. Frankly, Mark, we don't run the business on a month to month basis as tightly as maybe people think we do, and frankly this 1/12 metric was a bad metric, okay? I don't think anybody else uses a 1/12 metric where you compare this month's orders over the same month the prior year. It just leads to too many gyrations. You have the days in a month issue that you have to deal with. People have to make adjustments. They don't make adjustments. We're getting calls. Pam Huggins spends most of her day after the orders goes out trying to explain every market in detail by region, and it just drives you nuts. I said there has to be a better way to do this, and so the one thing that we decided was first of all let's get to a 3/12. That tends to smooth out the gyrations that you get on a monthly basis -- tends to smooth out the number of days in a month and the number of days in a quarter over a three-month period. When you compare three months over the last year to the same three months you will have a much better comparison than the comparing one month over the last year to one month. That's one of the changes that I think is going to be a real positive.

The other thing is it is going to be consistent or concurrent with our earnings guidance, and that's what I think is most important. You're going to still have the opportunity to get that order information and have the guidance and outlook at the same time so that you can take all the information at the same time and make a decision as to what do you like or what you don't like about what's going forward about the Company. We think it is a positive. I think we made another big positive change in the order reporting, and that had to do with the total. And I think Alex certainly helped us and guided us a little bit in that respect, and we thought this was a great idea because people were getting that and pick the first number they saw off the earnings release, and if it happened to be North American Industrial, it was North American Industrial.

The last thing I would say is this company is not North American Industrial any more. This company is not North American Industrial, and I think people think we're a bellwether for North American Industrial. I think we're proving to you every quarter now that this company has a much different balance than it ever has in the history of the company. And that half of our business now -- if you look at our international industrial business, it is about comparable in size to our North American industrial business, and the margins are comparable. It is time for change. It is time to get people focused on the total company instead of focused on a particular region of the company. So all of that put together, it was a lot of discussion that went into this, and we just think that this is going to be a lot more meaningful for everybody, and hopefully you would agree with that.

Okay. Thanks for the input.

Thanks, Mark. We can take one more question at this time.

At this time there are no further questions.

Oh, well, then I guess we won't take one more. Okay.

Pam, if I could -- I want to come back in on Ned's question earlier and so forth. I want to make one point. We didn't have a chance then. Ned raised an interesting thing--how Parker is diversifying and really ties onto what Don just said. Our philosophy out here is that we are world leaders in about nine or ten technologies, and we're strong. We're a leader. We want to be the best at those technologies. And how do we diversify the company? We diversify as Don just said. One is by going more globally, taking our technologies around the world, other parts of the world, seeking opportunities -- maybe Greenfield, maybe acquisitions, so forth. And then the other which we touched on as well is also take those technologies into some newer markets. There are some markets that we really have not -- we have not gone with our technologies, but we're now seeing the opportunities to do so, and putting a platform together and taking it in there. So we think the Company is tremendously diversified, built around these nine or ten key technologies, and you are seeing it geographically, and frankly you're starting to see it as we buy into -- as we expand the filtration and the refrigeration and so forth. I just wanted to add that.

Thanks, Tim. We appreciate that. I would like to thank you for joining us today. At this time I am going to turn it over to Don who has a few closing comments.

Thanks, Pam. Well, I think everybody can see that we're on a track here for a great finish to fiscal 2007. We're certainly very optimistic about the future, the end of this year, and the beginning of next fiscal year and throughout fiscal '08. I think we've got a bright future ahead of us. Just a couple comments here. I want to thank everyone on the call for your time and your questions. The results that we are achieving, as I said earlier, are direct result of our execution of the Win Strategy, and if you want a definition on that, it is all about operational excellence and growth. Everything we're doing about here is trying to take this company to a higher and higher level, and I think you can see that proving out as time goes on.

Our emphasis is not always on maximizing the return on sales. That's not the number one objective. We have a 15% goal in the company. Our number one objective is maximize return on total capital. We think that's the most important metric. That's what we're focused on. Yes, we would like to get 15% ROS. That's our goal on this as well. However, we're not going to sacrifice the balance sheet to do it. We want to be prudent, and return on total capital is where we want to be at the top quartile of our peer group. And that's where we are today. We've maintained some very strong organic growth rate of nearly 5% in the company, so we're very pleased about that. That's going to continue to improve over time as we get further into our Winnovation, which is our innovation initiative we have going. We're filling the pipeline with some very exciting products. You're going to hear more about those as we go forward. We had a media day and just in the last 30 or 60 days -- and I guess it was about 60 days now -- and we presented some of the new things that are in the pipeline, and I think they're very, very well received. You will hear more about that as time goes on. Our fully diluted earnings per share reached another record in the quarter, and that was up 22% from last year. I think you can see our cash flows are strong, $537 million. Again, we did put about $161 million into the pension funds to true those up, so it is a great year.

Once again, I just to want to thank you for your participation. We certainly appreciate all of your interest in Parker, all of your questions, and certainly if you have any other questions, feel free to give Pam a call. She'll be available the rest of the day. Thank you very much. Have a nice day.

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