派克漢尼汾 (PH) 2008 Q2 法說會逐字稿

Good day, Ladies and Gentlemen, and welcome to the Parker Hannifin Second Quarter 2008 Earnings Conference Call. My name is Fab and I'll be your coordinator for today. At this time all participants are in listen only mode. We will conduct a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to Pam Huggins, Vice President and Treasurer. Please proceed.

Good morning. This is Pam speaking. I'd like to welcome you to Parker Hannifin's Second Quarter 2008 Earnings Release teleconference. Joining me today is Chairman, President, and Chief Executive Officer Don Washkewicz; Executive Vice President Sales, Marketing and Operations Support Jack Myslenski; and Executive Vice President and Chief Financial Officer Tim Pistell. Jack Myslenski is joining us today to provide some color on Europe in connection with the Q&A session at the end of the call.

Prior to proceeding to the Earnings Release, just allow me to address a couple of administrative matters. First of all, for those of you who are following this online, the PowerPoint slides have been presented and will remain there for some time. For those of you not online, the slides will be posted on the IR portion of Parker's website at PHstock.com. Second, as is customary, I want to call your attention to Slide 2, which is the Safe Harbor disclosure on forward-looking statements and again, as is customary, ask that you read it in its entirety if you haven't done so. And then of course, moving to Slide 3, this slide which is required indicates that in cases where non-GAAP numbers have been used, they've been reconciled to the appropriate GAAP numbers.

So at this time moving to the agenda on Slide 4, again, the call will be in four parts today. First Don Washkewicz, the Chairman, President and Chief Executive Officer, will provide some highlights for the quarter. Second, I'll provide a detailed review of the quarter, concluding with of course the upwardly revised outlook for Fiscal Year 2008. And the third part of the call will consist of our standard Q&A session. And as a reminder, you get this every quarter -- but please, please, ask one question at a time. I want to make sure that everybody has a chance to participate in the call. And for the fourth part of the call today, Don will close with some final closing comments. So at this time I'll turn it over to Don and ask that you refer to Slide 5 titled "Second Quarter Highlights".

Thank you, Pam, and good morning to everyone on the call. I just have a few comments and then Pam will return for more detailed review of our First Quarter. First of all, just some highlights for the quarter and for the half. We are certainly very pleased with the strong First Quarter and half of the fiscal 2008. In addition, we see enough strength now for the balance of the year to increase our earnings guidance and we have just done that this morning. This confirms our views that we should produce another record year of sales and earnings, which would be our fifth year in a row of record results for the Corporation. And then I think that in itself kind of goes to show that we have exhibited pretty strong strength pretty much across the cycle.

Our record results this quarter again highlight Parker's new balance. Our sales again in North America made up nearly half of our revenue in the quarter and this was pretty typical of what we saw last quarter. We are very pleased with the ongoing growth in Europe, Asia, and Latin America and will have an opportunity to talk more about that later in the Q&A. In fact, organic growth in the international industrial segment during the quarter was up over 11% and we're very pleased with that number.

In addition our operating margins in the quarter for our international business continued to exceed that for North America. As you know, this has been a seven year work in progress starting back in the early 2000s and working on to present, and we're going to continue to work on this to improve this even further. But our European team to date has done an excellent job executing our comprehensive margin improvement strategy that we laid out back seven years ago. Operating income in our industrial international segment increased nearly 44% compared to the same quarter one year ago and that's on a 27% increase in sales. Lastly, organic growth continues to be a very healthy 5% this past quarter despite some soft markets in North America. This level of organic growth exceeded world GDP growth in this last quarter, so we're very pleased with that as well. Earnings per share are up 12.8% and all of this is being driven by our employees' continued execution of the Win Strategy. We've talked about that before. The Win Strategy is our road map for operational excellence for the corporation.

Just a couple of comments on markets and again, we will have more opportunity to talk about various markets and market segments and regions later in the Q&A session. But keep in mind that we have about a two month visibility in industrial backlog and about one year in aerospace backlog. With that in mind our orders are up 10% in the quarter, so they are double digit versus year ago with particular strength coming from our international industrial and our aerospace segments. As was the case last quarter, our distribution remained strong and this represents about half of our Industrial business and we expect continued strength in this channel for the foreseeable future. Some North American OEM markets continue to be weak and nothing new here because we've talked about these in the past. They are automotive, heavy duty truck, refrigeration, and residential air-conditioning. These markets have been performing at this level for quite some time now so that when they return to more normal growth levels we should be in a position to benefit from that improvement. So with that, I'll turn it back over to Pam for a little bit more detail on the quarter.

Thanks, Don. And I'll ask you to please reference Slide 6 at this time. To summarize, earnings per share for the second quarter came in at $1.23. That's a 13% increase over the $1.09 in the second quarter of last year.

Moving to Slide 7, the earnings growth -- and I'm going to do this on a segment reporting basis for the quarter versus the same quarter a year ago, so to provide detail on that earnings growth, first revenues in the quarter increased 13% due to the industrial international and aerospace segments with revenues up 28% and 7% respectively. Second, the segment operating profit increased 13%, and this was again led by the strength in the industrial international segment with an increase in operating income of 44% for the quarter that Don just mentioned. Corporate, general and administrative expenses were 9% lower due to incentive compensation in the quarter and fourth, outstanding shares were lower, mainly as a result of the accelerated share repurchase program that was just completed in November.

Now, these higher earnings items were partially offset by lower aerospace segment operating income, primarily due to development costs, lower CIC segment operating income, of course due to their exposure in several soft markets that Don mentioned as well. And then higher interest expense, mostly the result of acquisitions and of course the accelerated share repurchase program that I just mentioned. One thing to note, however, that interest expense as a percent of sales compared with last year is flat. We also had higher other expense due to currency and on the consolidated statement, you will notice that taxes were higher due to higher income and a slightly higher tax rate. To summarize the puts and takes from the second quarter on a per share basis versus a year ago, operating income contributed $0.17 -- so quality quarter. Corporate, general and administrative expenses added $0.02, less outstanding shares contributed $0.03 and all of these were partially offset by the additional interest expense of $0.01, higher other expense of $0.05, and higher income taxes of $0.02. So, again, as I said a quality quarter, if you net these items you can see that the earnings were quality earnings, clearly were the result of better performance in the quarter.

Moving to Slide 8 and addressing sales. Looking at the top line, sales for the quarter of course gained momentum, increasing 13% to $2.8 billion from $2.5 billion last year. Of this 13% sales growth, 5% was organic, 3% the result of acquisitions, and then 5% the result of currency, mainly the Euro.

Moving to Slide 9, the strong growth in the quarter is the result of continued strength internationally with 11% organic growth, of course led by Asia, Latin America, and Europe. Latin America continues to show improvement. As we discussed last quarter, particularly in Ag in Brazil, and of course Asia and Europe continue to have double digit growth. Distribution and commercial side of the aerospace business continue to do well. Acquisitions continue to contribute and Parker continues to make progress in emerging markets.

So moving to Slide 10 and focusing on segment starting with industrial North America, I think most notable on this slide is that in spite of several soft markets, North American second quarter sales are up 3%. 1% organic, and of course, you can see that we're showing some momentum in this quarter in that particular segment. Margins increased to 14.3% from 14% a year ago, and of course this is the result of successful acquisitions. The result in diversification of our businesses, and of course, execution on the Win Strategy initiatives.

So continuing to Slide 11 with the industrial segment moving to international. Noteworthy here is that currency is becoming a larger contributor to sales -- it was 11% for the quarter and again due mainly to the strong Euro and of course as you know, the weakening of the dollar. Organic growth continues at a high level reaching over 11% for the quarter and in turn contributing to a nice improvement in margins coming in at 14.9% compared to 13.2% last year. And of course, acquisitions added 5% in sales in this segment. So international continues to do well across the various markets, and strength is expected to continue in the foreseeable future.

Moving to aerospace, most notable in aerospace in the margins in this quarter -- margins dropped to 12.1% from 16.9% a year ago. The decrease in margin this quarter is due to approximately $20 million in higher development costs in connection with program wins, mainly the 787. This was discussed at the last quarterly call; however, development costs moving forward are expected to be higher than originally discussed. I'm sure most of you saw the release this morning. We had a win on the A350, the fuel and the hydraulics system. So again, just to reiterate, as a result of program wins, A350 being one moving forward, development costs will be higher.

Moving to Slide 13, the climate industrial control segment. As Don mentioned, softness in automotive, heavy duty truck, and residential air-conditioning continued to affect this segment. About $10 million of the shortfall that we'll discuss later is due to business mix, moving from high margin, residential housing, business to lower automotive and about $7 million is due to the decline in sales volume.

I want to talk about orders a little bit here on Slide 14. As you know, we're reporting orders on a quarterly basis now. These numbers represent a trailing three-month average and are reported as a percentage increase of absolute dollars year-over-year, excluding acquisitions and currencies except for aerospace. Aerospace is reported using a 12 month average. Orders are up 10% for the December quarter just ended. This 10% is up sequentially from 7% last quarter and compares to 5% a year ago. North America orders have improved sequentially from a flat number last quarter to a positive 4% year-over-year, and this compares to a negative 1% the same quarter a year ago.

Moving to international, industrial international orders, they continue to show strength at 16% this quarter versus 19% last quarter and 13% last year. And of course this international strength supported by growth in Asia up 22%, Latin America up 17% and it continues to show improvement, and of course Europe remains strong up 14%. Aerospace is strong across all segments. Orders are up 19% this quarter, which compares to 12% last quarter and 10% a year ago. In the climate and industrial control segment, order strength as anticipated has improved. Orders are down 6% for the quarter, which is an improvement from the negative 13% last quarter; however, orders were down 2% a year ago.

Moving to the balance sheet, Slide 15, Parker's balance sheet remains solid. Cash on the balance sheet at year-end was $198 million. We have about $670 million in commercial paper outstanding. Day sales in inventory improved 1 day from 71 a year ago to 70. Accounts Receivable, speaking in terms of DSO, it's up one day coming in at 50 days versus 49 days last year, and the large decrease that you're seeing in other assets in pensions and other post-retirement benefits year-over-year is a result of FASB 158.

So moving to Slide 16 now, and just talking about cash flow -- operating cash flow for the quarter came in at $205 million, another record for the company. Of this $205 million in cash flow, $62 million or 2.2% of sales was used in connection with capital expenditures. Acquisitions consumed $430 million, dividends were paid in the amount of $35 million, and as a result of these items, debt increased by $318 million in the quarter.

On Slide 17, you can see the debt to total cap ratio is 29.7% and on a net basis, it's 27.6%, thus providing the capacity to generate premium or returns going forward.

I'll now address the guidance. On Slide 18 through 20, we have the guidance figures. Slide 18 details the guidance for sales and operating margin by segment. Slide 19, guidance has been provided for the items below segment operating income, and Slide 20 summarizes the guidance on an earnings per share basis from continuing operations. As you can see from this slide, the guidance for fiscal year 2008 for earnings per share from continuing operations is projected to be $5.15 to $5.40. This compares to the previous guidance of $5.05 to $5.35, so an increase of $0.08 at the midpoint. Please remember that the forecast includes acquisitions made to date, but it doesn't include any acquisitions that we may make going forward. So, the revised guidance as compared to the original guidance, just to give you some color as to what it incorporates, first of all an improvement in sales in all segments except climate industrial controls for the items that I just mentioned earlier. Increased operating margin in North America and the rest of world contributing $0.16 to diluted earnings per share, a lower tax rate contributing $0.03, higher interest expense due mainly to acquisitions $0.07, and then of course higher corporate general and administrative expenses, although general and administrative expenses as a percent of sales will be flat. So at this time, I'd like to turn the call, or I'd like to open it up to our standard Q&A session.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Robert McCarthy from Robert W. Baird & Company. Please proceed.

Good morning, everybody.

Good morning, how are you?

I'm fine, Pam, how are you? I heard an interesting comment when you were talking about Industrial North America. You said showing momentum. Are you referring to the improvement in order rate in the quarter or are you trying to tell us something a little broader than that?

You're exactly right. That's what I was referring to that the orders -- as you can see, they're starting to improve. I think Don has talked about that. I know when we have been on the road for sure, he's mentioned that. The interest rate has declined and it takes awhile for that to show up, but obviously you can see in the orders there is some improvement. So that's what I would reference, you're right.

And for my follow-up, let me ask about the revised guidance for profitability in the aerospace business. You're showing 14.1 to 14.5, down from a forecast that included 16 before. Is this strictly a function of increase in development costs associated with this new win, the A350 or is there more to it than that?

No, that's a very good question, and what has happened on the last call -- just to refresh a little bit, on the last call, we talked about our development costs and we said that we were incurring more development costs in the first half and that going out in the second half, that would decline somewhat and so you would see higher margins in the second half. That's what was said before, but what has actually happened, Bob, is development costs have been higher than we originally anticipated. For the year it's going to be higher due to the A350, but there's some other programs as well.

Are they being -- what's causing it, Pam? Are they being accelerated or do we have, are we having, are we finding that the scope of the programs are expanding or did somebody misestimate what they would be up front or what?

Really, Bob, this is Don. It's really a combination of all of those. Some of which are accelerated, some of which the customer wants us to explore two different options for a particular part of the system instead of one, so we have to put more resources and so forth on it. It's really the combination of all of that. And in addition to that, it's a result of a number of other programs that we won of late as well in a number of different categories including the regional jets, the business aircraft -- not only the 787 but some of these other areas as well, and other commercial airframes. So it's really the total level of activity is just increased dramatically and frankly, we just underestimated it.

Okay. All right, I'll get back in queue, thank you.

Your next question comes from the line of Nigel Coe from Deutsche Bank.

Good morning, Nigel.

Good morning, Pam, how are you? So just a quick follow on to the previous question on the aerospace R&D. Does the revised guidance anticipate further pushback on the 787 and maybe a flat up production ramp up next year or do you think you're pretty insensate to those assumptions?

Nigel, Tim Pistell. The guidance we have given you right now does not include any pushbacks to us on the 787 because we have not received any to date. So we are still performing to plan and of course things can change but we have nothing changed even in conjunction with our latest announcements.

Okay, great. And in terms of the -- again previous question talking about momentum building in North America, would it be fair to say that in North America started off a little bit weaker and then actually got stronger during the quarter? Maybe if you could answer that question in terms of international as well?

Nigel, this is Jack Myslenski. I'll try to shed some light at least on parts of the international numbers. And I might expound upon what's going on in Europe to preempt some other questions that may come up about what is going on there. But first of all, our after market sales continue to be strong year-over-year with a slight growth on a sequential basis. So our distribution has been doing rather well. And on the OEM side and I'm specifically speaking here about Europe, on the OEM side, we're very fortunate to have positioned ourselves in a number of very nice growth markets in Europe. Mobile construction continues to be very strong in the UK and in Germany, continues to be good in Italy, France, and Sweden, which are the other major countries where we're involved with construction. We've also positioned ourselves in that particular market in somewhat I would call some niche construction equipment manufacturers whose products end up in infrastructure building around the world. Everything about marine is booming. It doesn't matter what part of the boat industry you're in, it just seems to be roaring all over. Much of that marine market is being driven today by what's going on with oil and gas and some of the order books of our end customers are out as far as three years. We've also introduced some new innovative products, piping solutions for this particular market. We've rolled it out in Europe and it's doing rather well and we plan on rolling it out in other countries around the world where shipbuilding and marine industry is very strong. We've also done well in the forestry, pulp and paper markets, especially in Finland and Sweden, and as expected all of the businesses around oil and gas are very strong all over Europe. Interestingly enough, one of the things that's noticeable is we're doing a relatively good job in the heavy duty truck market in Europe, contrary to what's been going on here. Except I will make a comment about North America at this point. Even though the heavy duty truck market has been down and it appears to be at the bottom, and as a matter of fact we've seen some positive signs the last couple of months in that particular area. Lastly, our presence in alternative energy markets is reaping wonderful growth. This is especially true in the wind turbine market, in Europe and in particular in Spain and Denmark.

In closing on Europe, I'm very positive about the future growth that we have there, primarily because we have the organization set to be able to bring the true power of our products together. And the other thing that is interesting to watch is as companies move around the world, our sales company organization around the world has been able to seamlessly pass off the customers from one location to another around the regions of the world. And then a quick comment about North America -- distribution continues to be strong. Our government and military direct business is strong -- again, energy, gas, oil, mining are all strong in the U.S. I mentioned heavy duty truck. Heavy construction is still steady year-over-year. The only place where we've seen some softening there is on construction equipment that's related to commercial or residential building, so it's the smaller construction equipment. As Don mentioned semiconductors appears to be at the bottom but it is down. And then air-conditioning related to the housing is a challenge along with the cars and light trucks. So that's my flavor on the market both in North America and in Europe.

Very helpful, thank you very much.

Thank you, Nigel.

And your next question comes from the line of David Raso, from Citigroup Global Markets.

Good morning, David.

Good morning. I'd like to discuss the order of mix and how that dovetails into the margin assumptions for the rest of the year, essentially looking to keep the North American margins in the second fiscal half where you had in the first half international a little bit lower. Can you help us a bit, Jack, what you just went through on the end market, some color around the first North America, the pick up in orders, exactly the mix of that? You mentioned the idea of heavy truck a bit but maybe expound a little bit more on North America, where you're seeing orders pick up and how should we think of that as a business when it comes to the mix?

One of the things I want to say, when you're looking at the international margins, one of the things that you need to be aware of is if you look at the second half of last year -- and I know you know this, David, but I just want to get this out -- if you look at the second half of last year, our margins were 13.5%, moving up 130 basis points to the second half of this year to 14.8%. So that's a pretty healthy increase, second half versus second half. Yes, we are keeping it relatively flat going out, moving forward. But David, one of the things you need to think about too is that in the first half of the year, there's some things that take place with respect to inventory versus the second half that make some difference as well. We typically build inventory in the first half and we typically reduce it in the second half and when you're building it you get the benefit and when you're reducing it you don't. So that plays into that number as well.

David, a little color on Europe. On the margin side, we've been very fortunate when we go back and look at where we've been coming from and where we're at today. If you remember -- I'm sure some of the people on the call do remember -- back in the 2002 area, we were approximately making 6% profit in our international numbers. And although we don't tell you what our break down of those international s are, I think everybody knows that Europe is a main driver of our international numbers. We've implemented the Win Strategy in the three main initiatives there with the pricing and the lean and the purchasing. But along with that back in 2002, I outlined at one of our Investor Days what we were trying to do on the cost side and the delivery side. At that time, I mentioned that we were trying to improve our business by 3 percentage points with a stretch goal of 4%. I can tell you today that we've actually done that. We've reached our 3% and we're actually approaching the 4%, so the combination of the win strategies -- and if you take a look and just use round numbers, if you remember the 2 plus 2 plus 2, you throw in another 3 for the delivery system, that gets you approximately to the 15 that we're at today. So I'm happy that we have achieved those. I do not think that there's going to be huge incremental upside of what we can do on the delivery side with the exception of some improvements on the order processing. We've done pretty much what I think we can do on the warehousing and the field sales redeployment. I would point out that there are going to be some expenses in the second half in Europe and they're directed straight at improving organic growth rates there. We've recently opened up a new sales company in Turkey. We've actually done our first billing in that country this past month. We will be opening up a sales company in Switzerland and in Dubai in the second half. And the other place that we're spending some more money at is deploying further resources in the form of salespeople in Russia, Northern Africa, and in Eastern Europe, most of the "stan" countries. So there will be some expenses involved with the setting up of the sales companies as well as investing in some additional resources on the Street. So that's part of the reason that there's a little bit of a slight decrease in the margins on the second half and Europe or in the international numbers.

I appreciate the structural cost issues, thank you. My question though about the mix, just trying to think through high horsepower tractors in Ag [strong] or the way you run your company -- the seal division margins above the hydraulic margins. I'm trying to get a feel for when I see strength particular end markets and what you're seeing in your orders and how I can think about that modeling the mix, the margins, the way back in the day when instrumentation was ripping in the late 90's it was a very profitable business and obviously it turned down dramatically. I'm trying to get a feel for the mix to get confidence in the margins in North America staying flat in the second half. You helped a bit there on the international margins. Can you help me understand the mix of the end market as well, especially in North America?

Well, I think you're going to see some increase in heavy duty truck, first of all.

And that's a better than average margin business for your North American industrial business?

We do a pretty good job in the truck market, overall, and there are some, there's some divisions that are very much involved with that particular market. Last couple months we've seen some positive signs where especially Class 8 truck builds where sales have gone up and consequently, we've seen some nice order entry increases in those particular divisions. We've seen good growth in distribution, and as you know, our distribution margins tend to be a couple percentage points better than most of our OEM business. So I think that's the other place where we feel comfortable with the business going forward. The real crapshoots that we still have are the semiconductor market and the automotive market. So I think that the margins, the mix should hopefully improve going towards the distribution, which should support our margin numbers that we gave you.

And the order acceleration in North America was more distribution than OEM?

Yes, I would say that we probably are expecting more distribution businesses as part of the mix than we are the OEM.

David, one other, this is Don, one other thing just to throw in here is that when you look at the operating groups -- you understand the various operating groups in our structure, not looking at market segments and just the operating groups -- with the exception of CIC, the operating groups are double digit margins across-the-board, so a movement in one place or the other isn't going to make a big difference one way or another on the margin. It's because pretty much, all of those margins are over double digits on the operating level.

I appreciate the time, thank you.

Thanks, David.

Your next question comes from the line of Daniel Dowd from Sanford Bernstein.

Good morning.

Hi, Dan, how are you?

I'm doing well. So as I look at the reporting, the order book actually improving in North America. Can you give some context on if the U.S. rolls into a recession say in the first two quarters of this year, how quickly is that order book likely to deteriorate based on your experience in previous recessions?

Dan, this is Tim Pistell. Again, I think that as some people have pointed out that we tend to trail the ISM, some people say a month, some people say three, recently I've heard someone say six months but I think overall that the three months is about right. So again , I don't think we're ever smart enough really to know those things, but there would probably be a three-month lag built into the ISM. And now as we're indicating, I think there is a lot of issues that we know and we're reading every day on the consumer front. But frankly, on the industrial front, we're not seeing it and in fact, in the fourth quarter as you can see of the calendar, we actually improved everywhere except in international which was coming off some real high rates. So sort of -- I know it's a very interesting thing, we've been talking about this several quarters in a row with you people, that it seems like we're holding up real well and some of these other indicators don't show that. Long winded answer, I don't know if we truly roll into a recession on the industrial side we'll see that fairly quickly, a quarter later at the

Okay, so what I take away from that is if we are actually in a recession right now, there might be even in next quarter's results, we might expect to start to see the pain in industrial North America and I guess my next question would be given how much work you have done on lean and the Win Strategy more broadly, seems reasonable to expect that decremental margins, particularly in the industrial North America business in this next cycle should not be quite as bad as they've been observed historically. How would you suggest we think about what the decremental margins could look like under declining volume and revenue scenarios in Q1, Q2, as long as a recession continues?

Well, the way we manage the company and we've told people this for years, internally the way we manage our divisions and our groups is on an incremental or marginal return on sales and we kind of follow the 30% rule. So on an upturn, we would like to see it deliver 30% marginal incremental earnings and/or more, and on the downside, then we would like to either contain it to 30% or less. Now, a couple things can really throw you off there and they are -- if you have to do any major restructuring, realignments, et cetera, reduction of workforce, that can really add to that on the negative side. Part of lean enterprise is to keep the organization lean and make sure you have the people you need and not lose a lot of people. The other part of that would be inventory. If you're carrying a lot of extra inventory you've got to liquidate that. Our inventories are at historically low levels. We do not have a lot, neither do our customers or distributors, so we do not have that. So we think that having really lived lean enterprise now for five or six years, we clearly are much better positioned. But as I say, I just then refer back to sort of probably the 30% [MROS] rule.

Okay, that's helpful.

Your next question comes from the line of Jamie Cook from Credit Suisse.

Hi, Jamie.

Hi, this is actually [Chase Becker] in for Jamie today, how are you?

Hi, Chase.

Quick question, just in terms of your orders, just to ask it in a slightly different way, is there any way you can comment sequentially on what you're seeing in terms of the trends?

We can only tell you what I just told you in my comments at the beginning of the call. For the most part, trending up, but we're up against some tough comparison, which I gave you those numbers on the call. But other than that, I can't talk any more recent if that's what you're asking.

Okay, and then I guess a follow-up question, if I'm looking at your guidance for the top line in the industrial segment on the international side, it looks like you're implying growth in the second half of about 13% or so, which I mean I understand you have tough comps but that's a pretty big drop off in the second half of the year. Just trying to understand if that's something that you're seeing in a specific market. I mean it sounds like everything is pretty robust at this point but are you anticipating something in the next six months that's going to deteriorate on the international side ?

The only thing there you have to remember that we don't include currency. We don't include currency in the number, so that's why it looks like it's tailing off. If you add it back in, it's pretty close to the run rate.

Okay, and then last question, just on some brief comments you made on the commercial construction market. Any more color you can add just in terms of what you're seeing for activity here in the United States?

On the commercial side?

Yes.

It's actually been slowing quite a bit. We're not seeing a whole lot of activity. Maybe some improvement in the second half, but frankly, it really only touches the company when it comes to the CIC group and a little bit on the hydraulics side where we're actually indirectly affected because of construction equipment. So it's not a major major part of what's going on. We do think that there is going to be some improvement in the second half and we're actually planning on that, so --

Okay, great. Thank you very much.

Your next question comes from the line of Robert LaGaipa from Oppenheimer.

Hi, good morning.

Hi, Bob.

I guess I just wanted to revisit the exercise done on industrial North America and industrial international, but this time on the aerospace side. You mentioned that the development costs have been a bit higher or are probably going to continue to remain fairly high at least here in the near term. And if I look at the margins, the 14.1 to 14.5 --obviously that was revised down. But still if you look at it year-to-date, year-to-date numbers are 12.7, so it implies that an improvement in the second half. Can you just help walk me through where are the improvements going to come in light of the fact the development costs are going to remain high?

Yes, this is Tim Pistell. I think we have just had a very very heavy load of these development costs in the first half. I think kind of it (inaudible) -- certainly a lot on 787 as Don also mentioned and it's also regional jet, business jet. The 350 win is wonderful news and that's going to come more later. We have had some of that -- clearly we're spending money to win those contracts. So but there just was a lot more money spent and this is customer request, and you just have to do it. I mean you're in the programs, you have to do it, and to try to keep their programs on schedule. So that's what's occurred. We see that really abating right now. I mean a lot of this we think we have incurred and we do see this abating quite a bit in the second half, and that really -- the increase in the margins that we're going to have to have in the second half to get to the guidance we told you, that is where it's going to occur. I mean, that's the swing factor.

Terrific, and second question if I could -- this might be for Don. If we look at the balance sheet, obviously it's levered to its highest amount in five years. Not to say it's at a high level, it's just incrementally higher than it had been at the 30%. Could you maybe just talk about as you sit here today, you've completed the accelerated share repurchase program, made some acquisitions, et cetera. Obviously you had a macro environment is a bit uncertain at this point. How do you think of the balance sheet and the use of cash moving forward? And what you're seeing on the acquisition front, valuation multiples, all that kind of good stuff?

Well, we're looking at a lot right now. There are a lot of opportunities out there, we're certainly, we think the pipeline is pretty full right now of things for us to look at. There's a lot of activity going on with respect to acquisitions. As you know, the main focus in the past has been on dividends. Of course we want to keep the dividend increases going. We've got a 51 year record there. And then growing the business is going to be a main focus for us funding the internal growth innovation and then also the acquisitions that keep us at a 5% level. We've done a few acquisitions this year which brought us to about maybe 2.5% of sales, so we've still got about 2.5 to go in the second half. We think we can do that from an acquisition standpoint. And then obviously we've done a lot of share repurchase as you noted. We're going to continue to do share repurchase at the bare minimum will be to cover any dilution from stock option exercising. And then we're hopefully do more than that. A lot of that depends on the mix of what's happening at that point in time. Right now the mix is kind of shifting toward I'd say opportunistic acquisitions and acquisition activity. The multiples seem to be if anything maybe dropping slightly. I think it's still a little bit early to see that overall throughout all of the transactions we're looking at. I think it's going to take some time for that to whittle down. But overall, there's quite a bit in the pipeline right now that we're really looking at very closely. So we think that we can hit our 5% target for the year as we close out the second half, and hopefully we'll do a little bit more than that because again, last year, we're a little bit short of the 5%. I think we did about 2.5 or 3% last year and we would like to average about 5, so we could do a little bit more this second half, hopefully.

Just quickly on that valuation multiple comment, was that pretty much broad across the region or did that apply to maybe one specific region?

This is Tim and I would say that North America, Europe, about the same. I will, and here is the situation: No question that people cannot get the financing that they were getting earlier. People will not lever up. And so that clearly will drive the multiples down over time and that is a fact, that's a reality right now. What has to occur though is there's a lot of sellers with high expectations that were set earlier and it will take them a while to readjust their thinking. A lot of activity, though as I say, the activity level has not slowed down but we are going through this adjustment period. And that's the same both in the United States and in Europe. In Asia, every situation remains unique.

Terrific, thanks very much.

Thank you.

And your next question comes from the line of Mark Koznarek from Cleveland Research.

Good morning, Mark.

Hi, good morning. Question having to do with some of the comments that Jack Myslenski made a few minutes ago with regard to the margin improvement that has occurred in the international arena. It was fascinating that he said that you've captured the 6 percentage points from wins and then an extra 3 from delivery system. And it strikes me that that delivery system, a lot of that is salesforce reorganization. and that's a trigger -- you haven't pulled that trigger here in North America yet. As we talk to your distributors, they still complain that there's a lot of redundancy across the different groups that have different salespeople coming to see them rather than somebody coming in and representing one face of Parker Hannifin. So this is kind of a long winded preamble, but is there an opportunity to pick up 3 percentage points more of profit margin here in North America as you ultimately execute that salesforce reorganization over here in North America?

Well, this is Don, and I'll let Jack comment too if you'd like in a moment. Just to let you know that there has been an evolutionary change going on here in North America as well as the rest of the world. For instance, we've organized in the mobile part of our business under one entity, so we've got everything pretty much organized in a similar type of structure as we would see in a sales company in Europe. We have that going on in North America. Our truck business has also been organized along those same lines, so it would be unfair to say that we haven't done anything in North America. There has been a lot that has been done. A little less has been done on the industrial side of the business as compared to the mobile side of the business, so there would be possibly some opportunities there. We're not going to really try to quantify it at this point, and I think just leave it to say that it's more of an evolutionary thing that will be happening gradually over time as opposed to something that we're going to have to try to get done next year because we want to go slow. We've been very successful in North America operating the way we are. We recognize there's some opportunities to present ourself more as one Parker to the customer, and we want to do that where we possibly can so there will be changes made, but it will be more slow coming.

Okay, and then actually just one follow-up on the tax rate. The guidance is 29% for the year, and the first half was only 28% -- 28.1. So does that mean that we expect a more significant tax rate in the second half or are you really just rounding that 29%?

Mark, it's Tim. There were discrete items that did happen in the first half -- in particular, in Europe people changing tax rates. We had to make some adjustments as they lowered their tax rate that helped us get there. And so that is why the rate going forward. Clearly in this day and age on taxes, there is a lot of individual things that one must do to affect that rate. And it's just a question of how successful can we implement some of these tax plans. So I would hope that we can implement some but once again, Congress couldn't get to the R&D credits. The big example, we're on this ridiculous schedule of they do it's like six months, 18 months, they got caught up in too many other things and did not reup the R&D credits. Now we fully expect them to do that at a later date. So it's just, unfortunately, there's just a lot of (inaudible) discrete items. And so I guess hopefully, we've taken a conservative look and we'll be able to get some of those on a go forward.

Great, Tim, thanks a lot.

All right.

Your next question comes from the line of Andy Casey from Wachovia Securities.

Good morning, everybody. First question is, can you help me understand -- I'm trying to understand this other expense line. It had a sequential decrease from Q1 but the implied guidance expects a pretty decent acceleration in the second half. Can you kind of help me understand the puts and takes going on there?

Andy, as you well know in that particular category, there are a lot of things that affect that, but one of the things historically if you go back, you will see that currency was positive for us in that and it's just beginning to turn negative in that particular category. So year-over-year, you're seeing a big change as a result of that and that's projected going forward.

Okay, so the primary one is currency?

That's right.

Now, could you talk also about the input cost trends you may be seeing? Because there's a lot of movement in some of the spot markets for some of the stuff that you consume.

Well, as far as the raw materials, are you saying, Andy?

Yes.

I would say there's still some pressure on some of the raw materials, for instance the copper based materials and so forth, still some pressure there, some of the nickel based materials. But many of the other ones have plateaued over the last six months. And if anything right now, I would say we're not sure what's going to come here because we know the price of oil has gone up to $100 a barrel now and it's on petroleum based materials. And I think if we had a concern it would be what's going to be what's going to happen to those materials over time. I know that the President was just over trying to get the spigot turned on over in Saudi Arabia so maybe that will help bring that price down a little bit. But that would be where my concern would be. If you said, what's going to happen in the next 12 months as far as materials, it would be more so on the polymers and the rubber based plastics and so forth.

Thanks a lot, Don and while you're there, Jack, good luck in retirement.

Thank you.

Thanks, Andy. Thank you. We have time for just one more question.

Your last question comes from the line of Jeff Hammond from KeyBanc Capital Markets.

Hi, good morning. Jack, you mentioned the areas of strength you've seen in what's driving Europe. Any pockets of weakness either on a country or end market basis?

Well, the cars and light trucks are still not doing real well in Europe, so we've had some decline in that particular area, which affects a couple of our groups -- filtration and connectors. That's been one place that's been light. The machine tool business is not roaring. It hasn't been terribly bad, but it's been affected because there's not a whole lot of new automotive plants being built and consequently, it's had a spillover on the machine tool builders that are in primarily Germany and in Spain. Interestingly enough, there's quite a few manufacturers of equipment for the automotive markets in Spain and consequently, we've been struggling there because of that, but outside of that, most of the business stays pretty strong. I can't think of anything else that's been negative.

Okay, and then just moving back to North America, can you give us a better sense of how much differentiation or bifurcation there is between growth rates and distribution versus the OE side?

You almost got to go segment by segment, Jeff. It's a little bit difficult. Our numbers have been very strong on the distribution side, and I'd say they're in a faster rate than what we've been experiencing with the OEMs. But to quantify it, I'd rather not. It's just too difficult because the change pretty much in the construction market's been okay but it hasn't been booming. Ag has been good but it hasn't been booming. So I would say that if we're looking at a faster area of growth, it would be in distribution as opposed to the OEM.

Okay.

And I know that doesn't give you a lot of flavor, but I think that's what we're looking at the second half.

This is Tim. Just before we close this out right now, we have not talked about either Asia or Latin America at all. I think this has all been management by exception here which is what we do. But just to let you know that both of those regions are extremely robust, almost right across-the-board, so. And we foresee that continuing for some time to come as well.

Right, and I just want to comment as well that yes, you look at the guidance going forward and we have upwardly revised our guidance. So we're confident going forward that things are going to be good for fiscal year 2008. And with that I would like to just turn it over to Don who has a few closing comments, and I would like to thank you for your participation in the call today.

Okay, thanks, Pam. So I think basically what we've said so far then is that we're pretty much on our way to another record year at Parker based on everything we can see. This quarter we produced record second quarter results in sales and earnings and net income and earnings per diluted share. As a result of that, we feel very confident and felt very confident in increasing our guidance which now is $5.15 to $5.40 per diluted share. So I think that's all very positive for the company.

Just a couple of additional comments -- I want to thank everyone that's on the call for your time and for the questions. The results certainly that we're achieving are a direct result of the Win Strategy and all of the activities that have gone on and evolved around the Win Strategy over the last seven years. And it's going to continue to be an ongoing effort and there will be continued gains from the execution of that strategy. Again, our main goal just to remind everyone is to maximize ROIC, and what we want to do is to maintain the top quartile position relative to our peers. So that's what our goal is, our overall goal and everything we're doing is trying to drive us to that to maintain that top quartile position. We have a strong organic growth rate, that's about 5% now, and that's been pretty amazing I think when you look at the company because with all the soft markets that we looked at here certainly in North America to maintain a 5% organic growth rate, it's been gratifying. And this of course is in addition to the growth rate through acquisitions and we're going to continue to pursue acquisitions as I mentioned earlier. There's a number that -- quite a few that we're looking at right now and so that will continue on throughout the balance of this fiscal year. Lastly, we're continuing to generate strong cash flows, reaching new records there as well, and that of course is driving earnings per share north as well.

On behalf of the leadership team, I just want to also thank Parker's worldwide team of employees. I know that there's a number of them that are listening in and obviously, are very interested what's happening in the company from around the world, so want to thank them for their accomplishments and for continuing to drive the company's growth and profitably grow the company year-over-year. Once again then, just for the people on the call, I want to thank you for your participation. We certainly appreciate all the interest that you've had in the company and if you have any additional questions throughout the balance of the day, Pam will be around to answer those, so have a nice day. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.