派克漢尼汾 (PH) 2007 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the fourth quarter and fiscal year-end earnings release teleconference. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer section. (OPERATOR INSTRUCTIONS) Thank you, Miss Huggins you may begin your conference.

Thanks. Good morning, everyone. This is Pam Huggins speaking. I would like to welcome to you Parker Hannifin fourth quarter and fiscal year-end 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, please allow me to take care of just a couple of 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 that you read this statement in its entirety if you haven't already done so.

Moving to the third 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. These non-GAAP numbers have been reconciled to the appropriate GAAP numbers where applicable. Third for those of you online, you may follow along today with the PowerPoint slides that have been presented.

For those not online, the slides will be posted on the IR portion of Parker's website at PH.com with that out of the way moving to the agenda slide four. The call will be in four parts today. First, Don Washkewicz, the Chairman, President, and Chief Executive Officer will provide highlights for the quarter and for the fiscal year; second, I will provide a detailed review including key performance measures of the quarter and of the year concluding with the outlook for fiscal year 2008; the third part of the call will consistent of our standard Q&A session. And as a reminder, please limit your question to one at a time. We want to give everyone a chance to participate; and for the fourth part of the call today, Don Washkewicz will wrap up with some closing comments. At this time I will turn it over to Don and ask that you refer to slide number five, titled fourth quarter and full-year highlights.

Thanks, Pam. I would like to just extend a good morning to everyone on the call. Just a few comments before Pam returns for a more detailed review of the quarter and of the year. I would like to give you just some of the top-line highlights for the year. We are certainly very, very pleased that we are able to deliver another record year for the Company. And we set quite a few records. I will just mention a few of those, but as I go through here, I will highlight several additional ones as well. Record sales, record earnings, record cash flow and segment operating margin. And I will talk a little bit more about the operating margins in just a few moments.

This is our fourth year in a row where we have demonstrated record results pretty much across the board. Our results this year has led to a major Parker milestone. We are hopeful that we would cross that $10 billion mark and we did cross that this year. We ended up with $10.7 billion, so our employees around the world are certainly celebrating this wonderful achievement. We have had another milestone. We reached a new record in segment operating margin at 13.8%, and this is now the record going back over our 90-year history. We have never achieved that level of performance ever in the past. So another wonderful record for the Company. And I would just add to that that when you look at our International margin, our International has also set an all-time historical record, 90-year record for the company at 13.7%, and I might just draw the attention to the close -- closeness of those two numbers, 13.8 for the total and 13.7 for International. The balance there is better than it has ever been in the history of the Company.

Some other significant accomplishments for the year is earnings per share up 33%. So hopefully the shareholders will be pleased with that performance. Inventory is at a record low of 11.8% of sales. You may recall six years ago, we were at about 19% of sales for inventory. And we've made -- made a commitment that we are going to get that down to what was world-class at the time. That was 12. And now we have actually dropped below that at 11.8, and we are going to work ourself down from that level. So we have come a long way on our inventory reduction as well. Productivity is up 7%, and that's measured by sales per employee, and, of course, the inventory and the productivity is really a indication of the success of our lean initiative. By the way productivity is also a record for the Company this year.

The past year, we grew more than three times GDP on our compound annual growth rate over the last 35 years now. I was talking about in the past 5 years and the past 10 years, but really when you look back over the last 35 years, we have a compound average growth rate that averages 11%. That is a tremendous accomplishment as well, and we intend to keep that -- that record moving forward. Organic growth has been strong. It was 5% this last year despite some soft markets in North America. And today, when you look at the Company, we have the best global balance in sales and margins than we have ever had at Parker, making us a lot more resilient to the economic fluctuations in the marketplace.

I might also point out that we had another record. The fourth quarter was the first time in Parker's history where the International industrial sales were greater than the International North America -- or the North American industrial sales. This was the first time ever that we exceeded North American industrial sales with our International segment. Just to kind of go to showing you that the change that's happened in the balance of the (inaudible) over last several years. So how are we doing this?

How are we accomplishing all that? Our employees are certainly driving this change by executing our Win Strategy. The Win Strategy is our road map to operational excellence and profitable growth and I would have to tell you that every employee worldwide is engaged in this effort and will be going forward. Our shareholders have been rewarded this past year. Total shareholder return was 28% which is 35% higher than the returns from S&P 500. I am going to talk a little bit about markets, not a lot, as we get into some of the dialogue, we will talk more about markets, but just a few comments.

Distribution remains strong, and that's about half of our industrial business. I want to draw your attention to that. We have about 12,000 distributor locations around the world now. And that segment of our business is -- is very strong and continues to be very strong. Some North American OEM markets as most of you are aware that are on the call have been moderating as expected. Those include heavy-duty truck, residential air conditioning because the housing starts were down, automotive, and certainly residential construction. So some of those segments are down, but they are being offset in part by our distribution business and the aftermarket.

Just to keep in mind that we have about two months of visibility and industrial backlog band a one-year visibility in Aerospace backlog. With that in mind, our orders were up 3% in the quarter versus a year ago with particular strength coming from our International industrial and our Aerospace segments. We will talk a little bit more about markets in a few moments here. But at this point I we will turn it back to Pam to give you a little bit more detail on the quarter and on the year.

Thanks, Don. Now we will begin with earnings release. If you could please move to Slide Number 6. Commencing with earnings per share, you can see in line with the press release this morning, earnings per share came in at $1.84. This is a 19% increase over the $1.55 in the fourth quarter of last year. You should note, however, that this excludes a $0.04 gain related to the sale of a metal building business that was to book of last year. And I am sure you remember we talked about it at that time. For the total year, improvement in earnings per share from continuing operations was 33%. Increasing to $7.01 this year from $5 .28 last year.

If you will move to Slide 7 at this time. So what were the components of the strong earnings growth on a consolidated reporting basis in the quarter and for the year versus the same period last year? First, the revenue increase was almost 10% for the quarter and 14% for the year. This growth in revenues was mostly due to the International segment with revenues up 30% for the quarter and, of course, even higher for the year at 34%. Gross profit increased 16% for the quarter and 21% for the year. Again this was led by the strength in all of our markets and the International segment with an increase of operating income of 35% for the quarter and 51% for the year.

We had higher other income as a result of one asset, writedowns in the fourth quarter of last year that weren't repeated this year, and for the year other income was higher as a result of -- a loss on the sale of business thermoplastics which you'll recall, we talked about last year as well. As well as some gains on real estate and there was a gain from resolution of an item in connection with a divestiture which we talked about at that time as well. We had higher share repurchases in the year versus last year that Don mentioned. 212,000 for the quarter and 5.4 million shares for the year. Now these higher earnings were partially offset by higher selling, general, and administrative expenses. This was due to research and development. We have been talking about that for some time in connection with the Winovation program, higher incentive, pay and professional fees. We also had higher interest expense due to higher rates in connection with commercial paper outstanding in the year and then of course, higher taxes as a result of increased earnings, which was partially offset by a lower tax rate down to a little over 28% for the year, down from 29%. When you net these items, you can see that we had quality earnings in the year, clearly the result of better operating performance.

If you move to slide 8 at this time, sales. Looking at the top line. You will see that sales for the quarter are up almost 10%, increasing to $2.9 billion from $2.6 billion last year. Of this, 10% sales growth, 5% was the result of acquisitions. 2% the result of currency, mainly the euro and of course 3% organic growth. For the year, sales were up 14% as I mentioned earlier and as Don mentioned surpassing the $10 billion mark for the first time coming in at $10.7 billion. 6% of this growth is due to acquisitions, 3% from currency, and 5% core growth.

At this time, move to Slide 9. The strong double-digit sales growth in the quarter and for the year, again, the result of continued strength Internationally. The organic growth International was 13%. And, of course, Asia Pacific and Latin America remains strong. In Europe as well. As you know, Europe continues to be robust. Distribution strong as Don mentioned, acquisitions, and then the commercial side of the Aerospace business continues to be strong.

Move to slide 10 at this time. I am going to focus on the segments for a moment. Starting with North America. What is most notable on this slide is that in spite of some softening markets, the fourth-quarter margin increased to 15.6% for the quarter. The second notable item is that operating income was slightly better with a decrease in organic sales. This is the result of successful acquisitions and, of course, the result of diversification of our businesses and then execution of our initiatives.

Moving to Slide 11, continuing with the industrial segment, moving to International, and on this slide what is noteworthy here that currency is contributing to sales 6.5% for the quarter and 7.6% for the year due mainly to the euro and the weakening of the dollar. Organic growth continues to be high at 13% for the quarter, finishing the year at 12.5%. This growth contributed to a nice improvement in margins reaching 13.7% for the year up from 12.2% last year. So International continues to do well across the various markets, and strength is expected to continue until the foreseeable future. The volume (inaudible) is broad base and reflects higher revenues in all regions, Asia Pacific, Latin America, and Europe. And in Europe particularly Germany.

Moving to Slide 12, the Aerospace segment. The business continues to operate at a very high level, and this is projected to continue for some time into the future as well. Most notable in Aerospace is the increase in the margin to 16% for the year, and we think this is very good, especially when you consider the high R&D costs in connection with new product wins, and it's also a time of high commercial OEM growth that you know carries lower margins.

Moving to Slide 13 and Climate and Industrial Controls. Just as a reminder, Climate and Industrial Controls is coming off of a very high SEER 13 sales year. For those of you that don't remember SEER 13 stands for seasonal energy efficiency ratings. The regulations change caused units -- a high demand for these units that has now fallen off. This along with automotive accounts for the decrease in sales in the fourth quarter. Even with that softness, operating income was consistent with last year.

Moving to Slide 14, Orders. As you know beginning with fiscal year 2008, Parker will be reporting orders on a quarterly basis and in connection with the earnings release. Orders will continue to be reported by segment, but they will be reported as a trailing three-month comparison. Orders will be reported as a percentage increase of absolute dollars year-over-year, excluding acquisitions and currency. As you can see from the chart, orders are up 3% for the June quarter, and this is in spite of tough comparables and softness in some of the markets. Orders through distribution continue to be strong. And while North America's growth has moderated orders in Industrial International continue to grow at high levels as evidenced by the 14% growth that you are seeing for the quarter just ended.

International strength is supported by growth in Asia, Latin America, showing improvement and Europe will remain strong. As I said early -- earlier particularly in Germany. Aerospace, OEM, and MRL continue to be strong on the Commercial side. And in the Climate and Industrial Controls segment, order strength as anticipated has moderated again due to the higher comparables as a result of the SEER mandate that I talked about earlier.

Moving on to the balance sheet slide 15, as you can see, Parker's balance sheet remains solid. Cash on the balance sheet at year end was $173 million, and no Commercial paper was outstanding. Inventory as a percent of sales is 11.8% versus 12.6% a year ago. Nice improvement. And accounts receivable in terms of DSOs down two days coming in at 49 versus 51 days last year. The large changes that you are seeing in the captions "other assets and pensions and post retirements on the balance sheet" is the effect of the accounting for FAS 158 which is different this year.

On Slide 16, moving to cash flow, we did make a voluntary contribution of $161 million to the pension plan this year. You can see that in spite of that operating cash flow remains very strong at $955 million. That really is another record for the Company looking at the slide. You will see that 955, you see that in both years, but last year it was a little less than that. We rounded up and this year is a little more than that so it really is still a record for us. We used about $238 million or 2.2% for capital expenditures this year. We consumed about 379 on acquisitions. We did share repurchases to the tune of 433 million. And we paid out $121 million in dividends. As a result of this, the more debt increased by $154 million for the year.

On Slide 17, if you look to that, you can see, however, that the debt-to-total cap ratio is 21.4% obviously providing the capacity to provide continued returns to our shareholders.

Moving to slide 18, I address the guidance at this time. On slide 18, the guidance for sales and operating margin by segment have been provided. I am not going to recite those numbers.

Moving to slide 19, the guidance has been provided for the items below segment operating income.

And then on slide 20, the guidance really is summarized on this on an earnings per share basis from continuing operations. You can see that we are expecting guidance to be $7.20 up to $7.60. So that really is the range going forward for fiscal year 2008. Just to give you guys a little more color on the guidance, the first half versus the second half, sales are projected to be approximately 48, 52% first half, second half, and the income just slightly different at 47 for the first half versus 53% for the second half. So as you can see, the guidance incorporates improvements in sales, operating margins, corporate administration, interest expense, which is partially offset by less other income and higher taxes. So I think that takes us through the quarter and the year-end results. So at this time, we will open it up for our standard Q&A. And after that we will close the call with some closing comments from Don. Thank you.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of David Raso.

Good morning.

Good morning, David.

Hi, good morning. A question on the guidance. North American industrial. I am trying to get a feel for the pricing environment and really also trying to read that fourth quarter margin. Was there something unique in there? Obviously it was a pretty strong number given the revenue guidance. Can we first just flush out the fourth-quarter margin and then try to extrapolate that to the guidance?

The -- if you look at the fourth quarter, David, I think you will see the impact of a little bit of a mix change to a more dominant distribution versus the OEM. As I indicated earlier, the OEM segments, heavy-duty truck and construction -- residential construction, so forth, these OEM segments have been weaker, relative to our aftermarket segments. So the margins on aftermarket part of the business are better, and that will translate into better margins there. As far as pricing is concerned, pretty much the same thing holds true here as what we said in the past, that at least on the aftermarket part of our business, those price changes would go in effect January or July, and, of course, would be moderated relative to prior years because of the raw materials have not been escalating at the same pace in recent months as they have been in prior years. So we would not expect to see the same order of magnitude in the way of price increases going forward. And, of course, at the OEM level, it is everything is based on contract, as far as pricing is concerned. So it is basically a one-off situation at each one of these accounts. Does that answer that -- your question?

It does. I am just trying to square up -- in the field we are hearing about the tube fittings, the division -- being a bit aggressive on trying to win some new business with improved rebates for the distributors. But you are not offering the same deal to your -- to your existing customers. I am trying to square up, is that a program simply to try to drive the top line and get aftermarket share? And by not offering it to the existing customers, is it a reflection of you still feel pricing can be reasonably solid as we start fiscal '08?

Well, I don't know specifically what exactly they have going on. I think they have promotions -- our divisions have promotions from time to time that they run in various segments of their business. So I suspect that this is just another one of those promotions that is kind of in the normal course. And like I said before, the other customers are all price based on a contract price on a quote. And when those come up for renegotiation, then we would revive the pricing if need be at that time.

And lastly, on the guidance on Aerospace, just trying to understand the -- the revenue guidance in particular. I can understand some of the costs will be ongoing with the A380 and maybe some last little bit on the -- the new Boeing planes, but I am trying to figure out the revenue guidance. The orders haven't been fantastic lately, but they are still running solidly up. You are certainly guiding revenue flat for the year essentially. Can you help us square that up?

Yes, David, this is Pam Huggins speaking here. What is really happening is, you are right, those orders still do look fairly good. And that is a result of obviously the Commercial side of the business, the Commercial side of the business will be fairly good next year. Unfortunately, it is going to be offset by the defense, which is actually decreasing. We are seeing actually seeing a decrease in the OEM and the aftermarket part of that business. And we talked about this a little bit before, but we do have some spares -- we had a couple of spare contracts that have been completed that were fairly large, and those contracts have been shipped complete, and won't be repeated next year. So that is really what is happening. The Commercial Aerospace side of the business continues to be robust, offset by the defense.

Okay. Thank you very much.

Your next question comes from the line of Robert LaGaipa.

Hi, good morning.

That was a different way of pronouncing your name there.

Yes, that surprised me as well. I just had two questions. I guess on the balance sheet and the use of cash flow. Obviously your balance sheet is in phenomenal shape, and if I look at the share repurchases this year, you did roughly 5 million in the front half of fiscal '07 and only 500,000 in the second half. And if I also look at -- the acquisition activity. The acquisition activity haven't been especially strong this year. And in light of the interest expense you are expecting to be down about 30% for next year. Should we imply by that that you are pulling back on the share repurchases and acquisitions and putting more cash towards debt? Or maybe if you could just provide a little bit more color there, that would be great.

Well, Robert, the -- this is Don.

Hi, Don.

This past year basically our mix was dividend increase, 13%. I think it was 5 million shares repurchased for $400 some million. And then we made a discretionary contribution to the pension fund of 161 and acquired 260 million in revenues. What we are doing this coming year, of course, we discuss this at each Board meeting. We have a Board meeting that's coming up and we understand -- we know where our leverage is at and it is not optimum at this level and we will be discussing some actions that we might want to take. I can't tell you what the mix will be at this point because we haven't had those discussions, the one thing I will say is we have not given up on acquisitions. Acquisitions are interesting because you can go from acquiring 2% one year to 10% the next year and it's just a matter of when you get them to the finish line. So it is unpredictable. It really is. So I would just say don't think that we have changed our focus at all. It haven't changed at all.

We are looking at a lot of potential deals when -- in fact, in this past year, we have actually passed on a couple that actually just were priced way out of line, and we didn't see any return for the shareholders. So we are going to be disciplined in what we do in that area. But we are focused on it. We still are going to grow 10% a year. We said we had a 35-year record that actually now is 11. And about half of that is going to come from acquisitions. So you will hear more on what we plan to do, but it is going to happen after -- after these Board meetings.

Terrific. Second question if I could just on the Corporate expenses. You are expecting them to be down in fiscal '08. I would have to go back to fiscal '02 to find the last time the absolute level of corporate expenses were actually down. How much of that related to the pension expenses potentially being lower versus other items?

Bob, this is Tim Pistell.

Hi, Tim.

It is not the pension per say. If you are looking at the pure corporate G&A line where it did spike up to 1.7% of sales. We like to contain that to 1.5% of sales or work it down. There were some extraordinary events that occurred here, the biggest of which really was in the R&D. We spent a -- we allocated a lot more money to some programs that you'll be hearing about as part of the Winovation effort.

Number two, there were quite a pickup on professional and legal fees, and a big chunk of this is it is in public now. We announced the change of our auditors and we had to go through a very crash program to wind up a bunch of consulting agreements here and it was a huge effort under way here in the last couple of quarters to get those projects done and this was mostly in the tax and IT areas. There were some really extraordinary costs. Some of that you could see the benefit in the tax rate.

Then of course the last phenomenon was great performance for the Company and an all-time high share price which did tend to cause a spike in the incentive pay. So I think that the professional legal will drop way back down and some of these others will go away. It is very much our intent to get this back to 1.5% of sales. No more than that. And try to work it down from there.

Terrific. Thanks very much.

Right.

Thanks, Bob.

Your next question comes from the line of Ann Duignan.

Hi, Ann.

How are you guys doing?

We're good, thank you.

Don, can I pick up on your outlook for industrial North America. Just building on what happened in Q4 with the mix switching a little bit to distribution versus OEM. In your outlook, could you give us some flavor of how you see that reverting as we go through 2008 or do you see -- anticipate that there will be a recovery in some of these OEM markets as we go through '08? From macro standpoint, when do you think that mix shifts back?

Well, I would say that we won't see any changes in the early months, but we are hopeful that later in the fiscal year that we would see some improvement in North American industrial, the one thing that -- if you look at -- actually if you look at the ISM index, it is actually tracking slightly up now, which would -- which would mean that eventually we should see some of that. A lot has to do with the various market segments too and of course in the OEM segments where there are quite a few of those that are soft right now, but they should see -- we should start to see some effect later in the year.

You are not -- you are not seeing any change in demand out there or any inflection points in truck, residential or auto at this point are you?

Nothing right now, no.

Okay. And that does bring me to the second question that -- now that you're no longer issuing monthly order data and you are no longer giving quarterly guidance, Don, have you considered moving your reporting year from fiscal to calendar which would -- make it easier for you guys maybe to give an outlook for your forward 12 months?

We haven't really discussed that. There is no real plans right now to make a change like that, Ann. And I don't anticipate us making that change.

Ann, this is Tim Pistell. I just want to jump in to say that Parker did that decades ago because it really put us in a great position with the auditors, the external auditors, who have a huge crunch time at the end of the year and they have always looked at the Parker audit as being quite advantageous for them to fill that gap in the summer and we have gotten used to it. It does get us out of sequence with some people but sometimes we are six months ahead, sometimes we are six months behind. Obviously, today this is one we are exposed because we are giving you an outlook for the year which carries all the way out through the June 30, of '08 whereas other people are only out through December. So, we wrestled with it, but it seems to make sense.

Yes, that's helpful to understand the root cause of how you ended up with the fiscal year. I just think that when points like this, inflection points where there is very little visibility, it is tough for you guys to give a forward 12-month forecast. I appreciate that and I appreciate the color. I'll get back in line, thanks.

Thank you, Ann.

Your next question comes from the line of Jeff Hammond.

Hi, good morning.

Good morning, Jeff.

Tim, maybe to follow on -- the look into calendar '08. It looks your first-half versus second-half guidance is fairly normal, but maybe just give us a better sense as we look out into calendar '08, where do you see things maybe restrengthening? Where do you see -- what are your worry spots that might be weakening as you look six months out?

Well, let me tell what is built in and then we will talk maybe the worry spots. I think as we have already indicated to you that right now North American Industrial and CIC are in softened modes, if you will. And we have touched on the key markets that are creating that. And we do see that as Don indicated carrying on probably through most of the balance of the calendar year. We are seeing some indicators that things could be picking back up and we anticipate that they will in some of those markets in the first two calendar quarters of next year which is our third and fourth fiscal quarters.

What we said before, really in terms of Aerospace, we have a pretty good handle on that. And Pam has explained that we are losing short lead time and business out to defense, and what we are gaining is very long lead time commercial but pretty good, solid visibility there. Right now the International is ticking along, we think it will hold up pretty well. Increasing at a decreasing rate but that is sort of a sum total of it, and our outlook right now. And, again, -- now, the worry points that I will have -- of course, frankly is we are all worrying about how deep -- how deep this credit crisis or how high up the credit crisis is going to go and what is that going to do to the markets and the interest rates.

Now there is a lot of positives I see coming out of that and quite clearly some negatives. So the one thing that concerns me the most is that variable. I think the other thing that gives us some good feeling about '08 in general is the U.S. elections. A lot of politician will want to get reelected so they will be wanting to authorize spending a lot of money. And the Chinese want to have a good Olympics. So I think '08 could shape up to be a pretty good year because everyone is going to work hard to make it one. So that's my -- that is the macro outlook.

Okay. Then just as a follow-up for International. You have got some margin improvement there. How much of that is volume versus other actions and maybe specific to that, you had talked in your -- in your Fall Analyst meeting taking a harder look at some additional actions. Maybe just provide an update on your thoughts there.

Well, it is a combination of the two. There is no question. We took the Win initiatives to Europe, and we took -- we started here and took them there. We are seeing the benefits of all of those strategic initiatives coming through and that's part of it. The other part of it is that we have been talking -- we have built this infrastructure, and we are a lot bigger. Now we are able to pump a lot more revenue through the infrastructure that we had in place. And that -- that is serving us well also. So those are -- those are the two issues.

Okay. Thanks, guys.

Thank you.

Your next question comes from the line of [Andrew Casey].

Good morning, Andy.

Good morning, Pam. Good morning to everybody else. Question on the outlook again and looking at it from a bit of a different viewpoint. If you kind of combine the revenue and the margin, the incremental margin that I am coming up with is somewhere between 14 and 23 for total and then everything looks in line except for Industrial North America which has a fairly wide range of incrementals. Is there something within the margin performance that is still uncertain? Because I am coming up with a decramental of 30% up to a positive 27% and I am trying to reconcile that. Could you shed some more light on that please?

I am sorry, Andy, this is Tim. Are you talking North America specifically?

Yes, Industrial North America. There's -- that is really what -- what's kind of dampening on the low side, the -- the incremental that I am seeing for the Company, and I am not sure if your -- I am not sure what is going into that, Tim.

Yes, okay. I am sorry, I didn't understand the question. So, yes, the -- we are really deep. As you know we are obviously very deep into this expansion in North America Industrial. They came out first. The strongest. We started with some very high incremental MROSs and the deeper you get in, the lower they go. I think that we are -- we are definitely looking for a positive. We call MROS, marginal ROS, you call it incremental. We are actually looking for a positive MROS but albeit lower than it has been. At the lower end, the unfavorable may come up, but that certainly would be at the low end and something that we are not anticipating. We do expect positive -- but we do expect it to be lower than it has been in the last few years.

Okay. So it's more conservatism based on your experience as opposed to some pricing actions that were referred to?

Well, no, I would -- again, I would say it's more realism. We know that sometimes when you first come out of the recession in the first quarters you could be seeing 40% or 50% marginal returns. Then they start to fade down to 30. We like to run by 30, but of course, then you get into the 20s. You might get into the mid-teens. But, again, the other thing that has an impact on this is as you saw this year, we built some inventories in the first half of the year because business was good and orders were humming and we built a lot of inventories, the orders softened. We have been liquidating inventories. You are seeing that come through now. You can see the inventories have come down and clearly whenever you are liquidating inventories and we are still in that mode right now. That is going to impact your margins. That is going to carry on quite a bit into the start of next year. That is the other thing that is happening here.

Okay. Then the last question I guess is with the current issues in the credit market, are you seeing any more recent decreasing competition for some of the acquisitions you might be looking at?

Well, we have read a few articles about -- this is Don, Andy. We haven't seen that necessarily. But keep in mind a lot of the Companies that we would be pursuing would be companies that would have no interest in being acquired by private equity. That would be the majority of what we would acquire. These are privately held companies run by entrepreneurs that have no interest in private equity from the standpoint that they are more interested in finding a good home for their business and for their employees. And that's something that private equity can't provide. So to answer your question, we don't bump into them a lot. We do in some cases. I think based on what I have read, it might get easier because of the crunch here as far as capital. There are some big deals out there with Chrysler and others that are consuming a lot of cash that it could get easier from the standpoint we may see them less. But we haven't seen them a lot anyway because of what I just mentioned.

Okay, thanks, Don. Just to follow-up on that and I will get back in queue. Have you seen any changes in your acquisition pipeline?

Andy, this is Tim. I would just say that they report it me, the changes that we have more going on now than probably ever before. Again and I just want to turn the clock back slightly. As you know in fiscal '06, we acquired almost $1 billion of revenue. It was a huge year for us, and we had a lot of integration issues that we had to take care of. So we did get off probably to a slow start to '07 here because of that. Now we picked it back up. There is more going on now probably around here than ever before, but as Don says, it is just -- you never know when certain things are really going to happen.

Okay, thank you very much.

Thanks, Andy.

Your next question comes from the line of Alex Blanton.

Good morning, Alex. Alex?

Yes. I was just looking at your sales guidance, and if I do the math, the guidance on slide 18 comes tout to bout 3.4% sales increase for the bottom end of the range. I am just wondering how much of that will be just simply acquisition carryover. That is about [$267] million. How much is your acquisition carryover going to be from this year? Just with the rest being, let's say, flat.

Yes, Alex. This is Pam. We have about an incremental $146 million that is going to roll into--.

How much? 146.

Yes.

Okay. So that would mean at the bottom end of the rage you will have about $220 million, $221 million, about 2% increase, is that it?

A little bit higher than that, 2.5.

That -- okay. It just strikes me that this doesn't -- this is less than world GDP growth, and particularly with Europe. Europe is a lot stronger right now than you have indicated for '08, less than 10% increase. And I am just wondering, aren't you gaining market share because of the improvements you have made in your delivery times and your -- this doesn't seem to indicate anything for that.

Well, Alex, yes, and we feel we have done well certainly if you look at our performance having grown it three times GDP in total. Looking forward, we hope that we will do better. In other words, we have a two-month look as far as orders right now and on the Industrial side. We have a year on the Aerospace side. We are at the beginning of the fiscal year. If you look at us historically the way we have presented guidance in the past. We are consistent with what we have done in the past and that is give you our best look based on a very limited amount of information, and then project that going forward and hopefully be able to give you an update each quarter and change that as we see conditions change. So it really -- the methodology hasn't changed and we are hopeful that we can do better of course.

Yes, okay. Even at the mid-range it is roughly in line with world GDP. Secondly, I just got off a conference call with Oshkosh Truck just before yours at 9:00, and they have just acquired JLG this year, the access equipment company area work platforms. And a lot of their business is in nonresidential construction and things like that and maintenance and new facilities being built. And even some infrastructure. And they are talking about Europe being strong through 2009 or 2010. In other words, the strength in Europe being maintained, not just a flash in the pan. What are you hearing from your European customers? I mean this is obviously going to be very important as to whether or not this -- this boom that is going on over there can be sustained even at a lesser but good rates.

Well, I think you can see that we are optimistic certainly, based on the segment projections that we are giving you that International is going to be strong not just Europe but Asia and also Latin America. We think all the regions outside of North America are going to be strong. Certainly for this next fiscal year, and I would say to your point, Alex, probably beyond this next fiscal year based on what we are hearing from our customers. I don't think anything will bring us down any sooner than that. Hopefully it will continue strong growth into the next two or three years. Yes, absolutely, we think it is going to be strong. We are projecting it to be strong, and I don't see anything that will change that in the near term.

Thank you.

Thanks, Alex

Next question comes from the line of Mark Koznarek.

Good morning, Mark.

Good morning. I have a question on the outlook. Just a clarification to start with and I think you've already addressed this, but your outlook contains no assumption of acquisitions other than deals that have already concluded.

That's correct.

And they all -- it also assumes no currency movement from where we are today?

That's correct, Mark.

Okay. So the question here is on the overall margin guidance which is that is effectively flat. And it is up really about 20 basis points if you do the math, but that would assume no dilution from acquisition or very little. You only have this 140 some million carry in. And -- if you do the math for last year, the year just concluded, your margin improvement, if you exclude acquisitions which Tim has said in the past come in at like 7 to 8% operating margin. You would see that the overall margin for the year is up about 100 basis points. So it strikes me that by this outlook, you are effectively saying your Win Strategy has petered out and there is no more margin improvement to be had other than just leverage on revenue growth and since we are not -- you are not projecting revenue growth, we are not seeing margin. How would you comment to that -- regarding that conclusion?

Mark, this is Tim. Well, first of all, let's step back. We do have a margin improvement. So -- again, it's -- it's -- built into next year as we said. We have had an all-time record margin this year and we're looking to improve on it next year. So I would hardly say that the Win initiatives are coming to an end. We think they are going for many years and they are going to raise us to another level.

The one thing I will -- that is tempering this -- we touched on it some on Aerospace, should talk about a little bit more is in the Winovation, the R&D. We have announced that program, rolled it out, and we are encouraging people to spend a lot of the money -- a lot more money in the R&D area. Most of that is done within the business units. We have some money that we carry at corporate here to fund special projects, but the bulk of that money is spent out in the divisions and goes through their normal operating results. So we certainly are -- along with improving the margins, we are increasing significantly investments in R&D in the -- in the business units.

Tim, how much is that going up on a percent of sales basis versus recent trend.

Unfortunately I can't give that you number, Mark. But we will do some analysis and we should get it out to you people because it is certainly significant.

I mean this is material enough that if you weren't doing it you would have a more normal margin improvement.

In the short term.

Yes, in the short term and of course you'd -- what we are trying to do is preserve our -- secure our long term. But, again, as we have talked many times in Aerospace, what is going now in Industrial, is what we have seen in Aerospace for years. They have to spend significant millions of dollars today to try to win business two or three years out. And so that's -- that's what -- we think it is a great investment, and nothing -- nothing gets spent in this Winovations process unless it has gone through -- met the criteria and made it through the stage gate so it is laid out for it.

From your revenue outlook in the guidance, however, you are not expecting any revenue pickup from that R&D increase this year?

It's in the numbers.

Yes, there are some in there but the program is relatively new. There aren't huge increments at this stage, but, yes, there are some that are starting to come out of the pipeline. And if some come out bigger and stronger, we'll be able to be more -- be able to give you more numbers later

What would be your raw material inflation outlook?

Mark, there is Don. I would say that what we see happening pretty much across the board. There may be an exception here or there, but pretty much the raw materials are flattening out. In other words, they've been obviously over the last couple of years we have been talking every meeting here about them increasing, and right now, we see them plateauing, flattening out. We are not projecting a major reduction, but we are also not projecting a major increase in raw materials. That could change, but I think what the -- the softness in the North American economy right now. I don't think it will change. I think that -- I think hopefully they have peaked.

Then finally is cap spending expected to be up again?

I would say on cap spending, that you should probably target about 3% if you are looking at models and so forth. That -- that we have been running down in the 2s, somewhere in the 2s, and that what we are budgeting is around in the 3% range. So that would be -- that would be a good number for you to kind of target if you are looking at CapEx.

Don, just add on, we -- our authorizations finished well over 300 million this year. You see the payments made not -- of course not the authorizations. So we did authorize around 3% of sales. And they will eventually come through and have to be paid for.

One other thing I wanted to mention also just to let you know, I think it is important information, in terms of restructuring, I think this comes out in the -- eventually comes out in the reports, but we did incur about $20 million pretax on restructuring this year. That was about the guidance we gave you. $20 million pretax. Interestingly, it is almost exactly the same number that we spent the prior year. And, of course, Parker's position is that is an ordinary part of running your business. At year end and year out, you got to look at your business and take the appropriate actions and restructure. It wasn't a huge number and on a go-forward basis, I would say look about the same next year. And lastly, again, I just want to go back -- Pam said right up front, the quality of the earning share I think are fantastic. You look at -- in terms of tax rate -- we lowered the tax rate a little bit. That was a lot of hard work. Got the tax rate down a little bit but really only -- only $0.06 of the earnings this year came from the improvement in the tax rate. The rest of it came from operations and good solid performance.

Yes, we only really have time for one more question here so that we can turn it back to Don for some closing comments before we end the call.

Your next question comes from the line of [Daniel Dowd].

Good morning, Dan.

Good morning. Hey, I was wondering if I could ask you to comment on having made a great deal of progress on the International Industrial margins over the last seven years and they are actually closing in on the North American levels. Can you comment on over the next three to four years how you see that evolving? Do you see them stabilizing at roughly the North American levels? Could you see them actually going above the North American levels? Can I just ask you to comment on that.

Sure. Dan, there is Don. We have the same goal for our International units as as we do for North America now. We established an interim goal for Europe in particular several years back because -- which was less than our 15% target because they were so far behind 15% that we don't want it to look like mission impossible early on. But now that as we started approaching that 15, really a goal for the Company is to try to hit 15% operating returns. And I might just mention that when it comes to ROS. ROS isn't the most important metric that we target around here. It is an important metric of course, but the more important metric for us is return on total capital invested. That is the one with we are really driving internally here.

Now, coming back to the ROS. Sometimes I get the question, why don't you raise the bar again. If you can get the 14. Why don't you raise it to 15. If you get the 15, raise it to 16. There comes a time when you are doing your shareholders a disservice. Okay. Because when we are generating 15%, 14% to 15% operating returns and we have got our return on total capital at the levels we are at in the top quartile of our peer group, we are generating 4 points of EVA for our shareholder and that is good business. And to -- yes, if we wanted to generate higher levels we would probably be giving up or passing up on good business that would be generating good returns for the shareholders. To that point the goal for the Corporation is -- has been the same, it's going to remain the same at 15%. That holds true for all regions. And we certainly think it is achievable. And as achievable in -- International as much as it is achievable here and we just continue to focus on the things we have been doing here. We are going to get here.

Okay, terrific. One quick follow-up then. We have actually talked a lot about the Aerospace R&D costs, and obviously those costs are in general a good thing. Can you provide some guidance and really not really looking for the next 12 months, but rather over a three-to-four-year time frame. When do you expect those R&D costs to start to come down and how do you think about that piece of it?

Dan, this is Pam. As you know we did ramp up this year on the R&D related to the new product wins and going out into next year, and I know you are not specifically asking about next year, but it looks like next year we will be relatively flat with this year. Now, it is hard to say. We don't know what the wins are going to be going forward, but if you stopped time today and looked at it, you would say, yes, you might see somewhat of a relief on that thereafter.

The -- Dan, this is Don again. Maybe I could comment a little bit there as well. A lot of the big programs, of course, that we are working on now are the ones that are already announced. You know the 787 Dreamliner, the A380, the A350, of course, there could be more obviously involved in the A350. The question is, how many more of these are coming down the pike here in the near future. I don't see a lot but again that is on the big commercial side, but then we have the business side of the equation, we have the military side and we have the private jet side, and there is more activity going on in there in those segments. So order of magnitude probably not as much as now, but it all depends again if there is any big air-frames that are planned for the future.

Okay, thank you.

At this time, I would like to thank you for your participation today. And I just want to turn it over to Don for his closing comments. Thank you.

Well, maybe just to wrap up. Certainly we are very excited here about the great finish we had to -- to a fiscal year which as we talked had a tough North American component, but very dynamic International component to it, an Aerospace component. We are pretty excited about that and we expect another record year in fiscal '08 based on what we have told you today.

Just a couple additional comments. I want to thank everyone for their time and their questions. I thought we answered and engaged in a lot of good questions today, this morning. The results that we are achieving and to maybe one of the questions that was asked out there with respect to the Win Strategy. No, the Win Strategy is alive and well and it is -- it is -- it's active with 60,000 employees around the world. And they are the ones who are making this happen, and they are going to continue to make this happen and they made a record year for Parker this past year. So we anticipate staying focused on that. That's how we add value to this organization. We add value to the acquisitions when we execute the Win Strategy once the acquisitions come on board and we add value to our base enterprise by executing on the Win Strategy as well.

Our main objective as I mentioned is return on total capital and we are going to continue to maintain focus on that and maintain that at the top quartile of our peers. We are at that level now, we are performing at that level, and we intend to stay there. We've maintained a very strong organic growth rate of 5%. You have seen the guidance. Hopefully we will be able to do better than the guidance but the guidance is what we have given you so far and we are going to also continue strong on the acquisitions. As you heard from Tim earlier, we have a lot that we are looking at here, have been looking at, and hopefully we can get more to the finish line this fiscal year.

Fully diluted earnings per share we touched on. Reached a record in the quarter, up nearly 19% from last year, and for the year, earnings per share were up 33%, which is, we think, very very strong performance.

Cash flows. We will have cash to do whatever we want pretty much this year and you will be hearing more about our cash deployment strategy as time goes on here, but we are approaching $1 billion in cash flow for the Company, and that's a record as well.

I mentioned the operating segment margins again being record both as total for the Company at 13.8 and our International margins. That's a tremendous achievement in light of the softness in the markets that we serve, which really goes to the to the execution of the strategies that we have been implementing here over the last six years or so.

So with that, that is my wrap-up. I would just like to once again to thank you for your participation and we certainly appreciate your interest in Parker. If you have any other questions, Pam is going to be around the balance of the day, and I just want to wish you a great day. Thank you very much.

This concludes today's fourth-quarter and fiscal year-end earnings release teleconference. You may now disconnect.