派克漢尼汾 (PH) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2010 Parker Hannifin Corp Earnings Conference Call. My name is Josh, and I'll be your coordinator for today. (Operator Instructions) I'd now like to turn the presentation over to our host for today's call. The Vice President and Treasurer, Pam Huggins, you may proceed.

Thank you. Good morning. It's Pam Huggins speaking, as he just said I'd like to welcome you to Parker Hannifin's second quarter and fiscal year 2010 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.

As normal, let me just address a couple administrative matters prior to beginning with the actual earnings release. First, for those of you on the line, you may follow today's presentation with the PowerPoint slides that have been presented. And for those of you not online, the slides will be posted on the IR portion of Parker's website at PH.com.

Second, as is customary, I'd like to call your attention to slide number two. This is the Safe Harbor disclosure on forward-looking statements and ask that, if you haven't already done so, please read this in its entirety. Now moving to slide number three, this slide as required indicates that in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers.

Moving to the agenda on slide number four, the call will be in four parts today. First, Don Washkewicz Chairman, President, and Chief Executive Officer will provide highlights for the quarter. Second, I'll provide a review, including key performance measures of the fourth quarter, and of course, concluding with the fiscal year 2011 guidance. The third part of the call will consist of the standard Q&A session, and for the fourth part of the call today, Don will close with some final comments.

At this time, I'll turn it over to Don and ask that you refer to slide number five titled fourth quarter and fiscal year '10 highlights.

Thank you, Pam and welcome to everyone on the call. I want to start with a few highlights of our performance for the past quarter and also for the past fiscal year.

First of all, needless to say we're very pleased with the way Parker employees reacted to the conditions in our global markets over the past year. Their quick and decisive actions along with our focus on the win-strategy on generating cash flow allowed Parker Hannifin to deliver very strong fourth quarter and full year results in fiscal 2010.

First, I may cover just a few points for the fourth quarter, some highlights. We had our second consecutive quarter of year-over-year increases in order rates with a 35% increase this quarter compared with the fourth quarter of fiscal 2009.

This improved demand level helped us generate 26% growth in revenues for the quarter as conditions in our markets continued to improve. Importantly, our segment operating margins reached 13.9%, which is about 900 basis points above where we were just four quarters ago, representing, obviously, a wonderful recovery for us. Our industrial North American segment margins in particular reached 15.7%, which is above levels we achieved in the record year of fiscal 2008. Again, this reflects our ongoing success in executing our win-strategy.

Our incremental margins were an impressive 48%, representing the change in segment operating income as a percentage of change in revenues. Earnings per diluted share up $1.35 increased 342% in the same quarter last year. In our focus on cash generation was evident in the quarter as operating cash flow reached $377 million or 13.5% of sales, which far exceeded our 10% target. I'll make just a few comments about the fiscal '10 year.

Despite being slightly down on revenues for the year, we generated increased operating margins, increased diluted earnings per share, and increased cash flow from operations. As you may recall, last year at this time, we projected $1.50 in earnings per diluted share, and we're certainly pleased that our actual came in at $3.40. Fiscal year 2010 total segment operating margins reached 11.4%, compared with the 9.7% in fiscal 2009, so we, we hit that double digit number there and exceeded our 10% target for the year.

Cash flow from operations was $1.2 billion or 12.2% sales. Again, well above the 10% target that we had. Our cash flow performance really reflects our performance on working capital management throughout the year. Notably, we achieved this cash to sales ratio despite a discretionary contribution of $100 million to the Company--Company's pension plan. We used our cash to increase the quarterly dividend for the 54th consecutive year in fiscal 2010, paying out $0.26 per common share in addition to maintaining our share re-purchase program.

Our year-end balance sheet is very strong with a debt to capital ratio of 28.9%, and a net debt to capital ratio of about 21%. And certainly this forwards us considerable flexibility to invest in future growth for the Company.

So, summing it up, we delivered a very strong quarter and full year for fiscal 2010. When we look at fiscal 2011, we have issued guidance for earnings from continuing operations in the range of $3.60 to $4.40 per diluted share. And that represents about an 18% increase at the midpoint on approximately a 5% increase on sales. So, with that, I'll turn it back over to Pam.

Thanks, Don. For more detail on the quarter, I ask that you reference slide number six, and as usual, I'll begin by addressing earnings per share for the quarter. Earnings per share for the fourth quarter increased $1.04 from the same quarter a year ago and came in at $1.35 that's more than a 300% increase as Don just mentioned. On a sequential basis, earnings for $1.35 compares to $0.94 last quarter. Re-alignment and expenses in the quarter were $7 million, that's $4 million net tax or $0.03 and this compares to the $15 million, $9 million net of tax or $0.06 for the same quarter a year ago. Earnings per share of $1.35 for the quarter, exceeds the earning per share for guidance due to higher revenues in all segments of the business and increase segment operating income and this had a positive EPS impact of $0.27. A lower tax rate with a positive EPS impact of $0.06, due to favorable settlements in connection with IRS audits.

Reduced other expense with a positive impact of $0.08 due to currency and a favorable inventory adjustment and then higher corporate G&A expenses within EPS impacted of $0.07 and this was the result of higher market driven benefit expense.

As Don mentioned, incremental margin return on sales was a respectable 49% rounding up for the quarter, and as a reminder, margin return on sales is the difference in segment operating profit divided by the change in revenue for the quarter on a year-over-year basis. Moving to slide number seven, and laying out the components of the $1.04 increase of earnings per share from $0.31 to $1.35 for this quarter. On a segment basis that is, the significant puts and takes are as follows.

Revenues increased 26% in the quarter, mostly driven by the industrial segment and climate and industrial controls. However, increases in revenues were seen in all segments of the business on a year-over-year and a sequential basis. As a result of higher revenue, re-alignment initiatives and cost controls put in place, operating income was significantly higher in all segments resulting in an EPS impact of $1.30.

Corporate, general and administrative expenses increased due to the higher market driven benefit cost that I just talked about, and this impacted EPS by $0.12. Other expense increased due to pension, and inventory adjustments, and asset write-ups within EPS impact of $0.12, and taxes increased obviously due just to the higher income.

So, moving to slide number eight, and looking at the top line revenues for the quarter increased 26% to $2.8 billion from $2.2 billion last year. Acquisitions had less than 1% impact on revenues in the quarter. Currency decreased revenues by 1%, however, and the currency impact as most of you know was mostly due to the international, industrial segment as the dollar strengthened mainly against the Euro.

The result in organic or core increase in revenues was then 27%.

Moving to slide number nine and focusing on segments. Obviously, starting with industrial North America first. North America reported revenues increased 33% in the quarter versus the same quarter a year ago. Base revenues comprised the majority of this increase as acquisitions had no impact on revenues this quarter, and currency translation was favorable increasing revenues by 1%. The net result of our base revenue increased then was 32%.

Operating income increased more than 202% in this segment, resulting in a marginal return on sales greater than 42%. Operating margins were up 180 basis points sequentially, and 880 basis point above the same quarter last year. Operating margins in this segment for the quarter above the margins attained in 2008 when overall margins were at an all time high.

Continuing with the industrial segment, moving to international. Revenues increased 30% in the quarter, versus the same quarter a year ago. Currency translation was a deduction to revenues in the quarter of 3%. And acquisition had no impact on revenues in the quarter. The net result or base revenue increase was 33%. Third quarter incremental margin return on sales, such as fourth quarter incremental margin return on sales was greater than 60% and operating margins increased 260 basis points to 13.6% in the quarter from 11% last quarter and this compares to a negative 0.7% for the same quarter a year ago.

So, now moving to slide number 11 and focusing on the aerospace segment.

Base revenue increase in that segment was 5.9%. Versus the same quarter a year ago, as there was minimal impact from acquisition in, and a currency offset. Margins were up 40 basis points for the quarter year-over-year and on a sequential basis margins increased 230 basis points.

So, now moving to slide number 12, a climate industrial control segment. Year-over-year base and total revenues increased 27% for the quarter. Again, acquisitions and currency had no impact on this particular segment. Margins as a percent of sales were 8.5% for the quarter and this is comparatively speaking 7.7% compared to 7.7% last quarter, and 0.5% for the same quarter a year ago. And marginal return on sales in that particular segment was 38%.

Now moving to orders for the quarter. Slide number 13, details orders by segment, and just as a reminder, these numbers represent a trailing three-month average in our report -- and are reported a percentage increase of absolute dollars year-over-year, and again, this excludes acquisition and currency except for aerospace. Aerospace is reported using a 12-month rolling average.

As you can see from this slide orders are 35% for the June quarter just ended. This compares to 23% last quarter, and a minus 38% a year ago.

North American orders for the quarter just ended increased 46% year-over-year, and this compares to 30% last quarter and a minus 40% a year ago.

Industrial international orders increased 46% year-over-year. And orders were up 42% last quarter and down 43% a year ago.

Aerospace orders are down 3% for the quarter, which compares to a negative 22% last quarter and a negative 22% a year ago.

In the climate industrial control segment, orders are up 35% for the quarter, 38% last quarter and a negative 31% a year ago. So, now moving to the balance sheet.

Parker's balance sheet remains solid, continues to get stronger, cash on the balance sheet at quarter end was $575 million, and no commercial paper was outstanding. Inventory continues to be reduced. It's been reduced by $83 million since last year. However, currency accounted for $29 million of the decrease resulting in a net decrease of $54 million. Accounts receivable in terms of DSO is [48], down five days from the same quarter a year ago. And, of course, Parker continues to work and make progress on the weighted average days payable outstanding.

So, moving to slide 15, referencing cash flow. Operating cash flow for the quarter was $377 million, and as Don said, this represents 13.5% of revenues. On the year to date basis, and including the $100 million pension contribution, cash flow was $1.2 billion, representing 12.2% of revenues and exceeding the 10% goal.

The major components of, and uses of the $377 million for the quarter, obviously, we increased cash on the balance sheet by $195 million. $38 million or 1.4% of revenues was utilized in connection of capital expenditures. $52 million was returned to the shareholders through share re-purchases of $10 million and dividend payments of $42 million, that was paid down by $77 million. However, the total impact to debt was reduction of $126 million due to it a currency impact of $49 million. On slide 16, you can see that the debt to total cap ratio is down to 28.9% and on a net basis, including cash, 21.6%.

So, now moving to the guidance on slide 17. On slide 17, we see the guidance for revenues and operating margin by segment has been provided. I won't go through that. Moving to slide 18, guidance has been provided for the items below segment operating income. And on slide 19, the earnings per share has been--the guidance on earnings per share basis has been stated. As you can see from this slide, the guidance for fiscal year 2011 -- (sic see Press Release) for earnings per share has been projected to be $3.60 to $4.40 just as Don had mentioned.

So, please remember that the forecast excludes any acquisitions that may be made in fiscal year 2011. And the full year revised guidance assumes the following. Increased revenue year-over-year of 3% to 7%, segment operating margins as a percent of sales at the midpoint of 12.9%, corporate administration costs are assumed at the midpoint to be approximately $160 million, interest expense is assumed at the midpoint to be $100 million, and other expense is assumed at the midpoint to be $160 million as well.

So, if you total all of those, the below the line expenses total $420 million, at the midpoint and the guidance incorporates a range of plus or minus 1%. The tax rate projection is 30%. And a couple of points with respect to guidance before I close here. Sales first half, second half are divided 48%, 52%. EPS, the division first half to second half is 46%, 54%. Fiscal year 2011 includes higher pension expense of $34 million, re-alignment costs for 2011 are consistent with fiscal year 2010 at $50 million, and first quarter EPS will be less than the fourth quarter, just ended, and second quarter EPS will be less than the first quarter next year. This is line in line with a normalized year. However, total year, it's higher at the midpoint at $0.60. So, at this time, we'll commence with the question and answer session.

(Operator Instructions) And our first question comes from the line of Mark Koznarek of Cleveland Research. Mark, you may proceed.

Hi, good morning. You guys hear me?

Yes, go ahead, Mark.

Okay. Thanks. I am just taking--I'm kind of struck by the contrast between slide five where you go through all the highlights, real positive highlights of this year, and then slide 19, where we've got, what's pretty arguably a cautious initial outlook below consensus entirely and the last time setting aside last year, which nobody know what was going on a year ago, but the last time you did that was in fiscal '09 when it was pretty clear we were rolling into a downturn and nobody could have forecast lane and six weeks later, which really collapsed things. But this guidance suggests that you folks have a very cautious macroeconomic outlook, and so I'm wondering if you could review the macro assumptions that underpin the guidance here?

Mark, this is Don. Just a couple of comments about how we go through the process, the process of coming up with these forecasts. First of all, we do this at a group level and roll up the groups from the bottoms up.

We certainly were not expecting any heros for the day coming in that were real strong forecast, just having come off a very, very difficult year and a recession that's been the worst recession in 70 years, so we weren't encouraging that at corporate and we didn't get that and rightfully so.

So, when you look at what we came in with, we're coming with a 5% growth number, and an 18% earnings per share growth number at the midpoint, I would say that we did capture the street, not that we were trying to capture the street but we bracketed and, in fact, if we--the street's I think at [430 million] something the top end of our range is [440 million], in fact, the street was I little bit more bullish on the top line, and if we add another half a billion dollars on the top line I think we'll be at the top end of the range we'll be right on the street.

So, I think we're in-synch here. I think the question is, does, how bullish do you want to get early in this fiscal year? One thing that we try to do here is, is make sure that no matter what happens, we make our numbers, and so as a result of that, if we were to come in with a high end forecast, people would be spending day one as if we're going to make that high end number, and that's a dangerous thing to do, so you may have seen this, and we're pretty consistent like this year after year. We don't really change our MO here, so we pretty much forecast the same way. You can call conservative.

I think it's just prudent, especially in light of the fact that we've just gone through this very, very difficult period. And by the way, the growth number really is more like organic growth is like 7% at the midpoint because of FX. We show 5% here, but we had a negative impact of 2% from FX, so and at the high end of course, we'll, obviously have that covered with the high end of our range. That would be delivering another dollar per share at the high end of our range, so hopefully that sheds a little light as how we go through the process and why we do what we do.

Okay. I think that actually partially answers the follow-up, which is the 5% midpoint of the revenue, which you're now clarifying is really organic, 7% --

Right.

Just seems like your orders in the fourth quarter, 35%, you could have basically flat orders for the next nine months or so and still end up with a 9% top line number rolling into fiscal '11, so it almost seems like you're expecting the year to start strong from a revenue standpoint and then actually tip negative in the second half, is that part of the assumption?

No. I don't think that's what we would assume. I think we're saying that we can see out pretty clear through the end of the calendar year, and like we always said in the past we'll update you every quarter as far as what we're seeing beyond that.

Like we did this last year we didn't have a lot of visibility last year either, and but we kept updating you on a quarterly basis as things were rolling out, so I wouldn't say that we have a negative outlook on the year at all or on the second half or anything. We just have less visibility when you get past the end of the calendar year.

Mark. This is Tim, when we give you a 48%, 52% split first half, second half, what we're giving you basically is a constant rate because that upload from 48% to 52%, we get simply from work days.

We have more work days and that's pretty much the math of it, so it does say that we are where we are. We've recovered and collectively to--we went from [100] down to [65]

We back up around, a weighted average around [90], and we're sticking at 90 right now, and frankly that is what we're seeing. And there are some--the problem is, we do not know what's coming out of Washington DC. We do not know the outcome of the elections or what else is coming out of Washington DC and what it's going to mean to American businesses. I go over to Europe. I've got a coalition government in UK. May or may not hang together. We know it's a parliamentarian form. We've got [Merkel] in Germany doing the right things but under a lot of heat from a lot of people because they don't like what she's doing. So, I mean, I think that there is a lot of uncertainty around and it's not just in Parker Hannifin it's with everyone I talk to. So we're trying to be add prudent as we can.

Great Tim, that's helpful. Thank you.

Thank you, Mark.

And our next question comes from the line of Jamie Cook of Credit Suisse. Jamie, you may proceed.

Hello.

Hi, sorry, it's actually Peter Chang for Jamie cook.

I didn't think it would be Jamie. That's why I was waiting to hear your voice. Good morning.

Good morning. Good quarter guys. I had a question on the international incremental margin outlook based on your guidance. It looks like you guys are assuming something north of 75% in both low and high end of the guidance range. Could you provide some color on what's driving that on--if that was a result of the re-alignment costs you took this past year?

Yes, your numbers are exactly right. And I think you're exactly right. If you look back over the restructuring that was taken up in the last three years, a significant portion of that restructuring has really been in international. So not, you have a couple things coming on. As you move along in the year, you have the volume coming on, as well as the savings as a result of all that restructuring, so you're right.

And do you expect that, I know you're not giving 2012 guidance now, but I mean, that type of incremental is probably not sustainable. What do you think would be a sustainable incremental margin going forward past this year?

This is Tim, I think we've been pretty out and open how we run the businesses here, and the expectation is for people to operate around this 30% MROS, marginal return on sales. Now, in the early phase of an upturn or downturn the percentages will be higher. You could be caught with a [50%] or something, and over time it will come back--revert to the mean so to speak, and we want people to operate to that, so with that, we'll settle down in that 30% range, and that's how we operate.

Great. Thanks. I'll give somebody else a turn and get back in queue.

Thank you.

And our next question comes from the line of Andy Casey of Wells Fargo Securities. Andy, you may proceed.

Thank you. Good morning, everyone.

Good morning.

Just a couple questions and then I'll pass on. On the other expense, the [160], is that where the pension falls into?

Actually a portion falls, what we call below the line and a portion falls above the line. Of the, there's about $34 million that we're going to incur next year in terms of pension expense, and there's about, let me see--there's about $12 million I think of that $34 million, which is above the line.

Okay. And what other assumptions are you making in the Delta and other, the [160] versus what you did this year?

Well, one of the things that you have to remember in terms of other expense, well I want to clarify those It doesn't answer your question directly, but I want to make sure that people understand that in the first quarter we have more stock option expense in other.

Okay.

And you're asking about the full year.

Yes

Let me see here. Can we go on and then I'll get back to him on that. The [160] because it doesn't change that much year-over-year.

Okay. Then in terms of the guidance, it doesn't include acquisitions you were--you were careful to explain that. What sort of pipeline are you seeing at this point?

Well, we're basically looking--all the groups are looking at a variety of different opportunities out there, and in various stages, I should say,of review, so there's plenty out there. We're trying to be prudent here as far as what would be best for Parker Hannifin at this stage, And we're going to continue, that will be part of our cash deployment strategy is trying to grow the business when, from some acquisitions for sure.

Yes If I can add on in terms of, because it's the natural lead into what our capacity looks like and you know as we sit here today with these statements, we're looking at about $1.5 billion capacity without violating any of the parameters with the debt rating people. We are very protective of our debt rating, and live to that, so we have about $1.5 billion as we sit here today. If we assume no acquisitions and just stock piling cash, if you will, we will probably accumulate another billion dollars worth of capacity over the course of the year. So, as Don said, all groups are active, again, looking, but we're of course, going to be very disciplined.

Okay. And then one last one on field. The distribution channel, Don, can you kind of characterize what you're seeing? Is it still a defer lien restocking and keeping relatively lien inventories?

That's kind of what we're seeing. Again, I think the OEMs have always operated in that mode. They really don't carry a lot of excess, at least of our products. The distribution, I think, likewise, everyone's cautious at this point in the cycle they're replenishing to the extent that their orders are coming back and our distribution is performing better now, and it's a half of our industrial business approximately is distribution, so they're performing better, so, in fact, their stock levels are going up somewhat. But again, not to the extent that, they're trying to anticipate some wonderful growth coming forward. They're just trying to match their stock levels with the current level of activity.

Okay. Thank you very much.

Andy, before you go, I just want to answer your question with respect to the other category. We just talked about the pension going up and I think you're talking about the [130]to [157] at the midpoint. Exactly. Yes, that really is the pension.

Okay.

For the most part that's the pension going up.

Okay. Thank you very much.

Yes.

And our next question comes from the line of Nigel Coe of Deutsche Bank. Nigel, you may proceed.

(inaudible--missing audio) It's in very broad terms of your macro assumptions are, but the gap between your 4Q run rates and your fiscal '11 guidance is pretty stark. Can you maybe just talk about elements of the core sales, which you think are sustainable. Obviously operating leverage is very strong, but was there any undue benefit from inventory re-stocking during the quarter that may be pushed up the EPS a bit more than what otherwise would be the case?

Nigel, this is a day-to-day thing, I have to tell you. When we put this thing together and finalized it a couple months ago, actually there was a lot of pretty bleakness out there and we were going through a lot of positives too it seemed and we, maybe we were being too prudent. Once, again, in the last few days this week, and talking to our peers and seeing what they're saying, again, I think it's sort of, but--we will lose. We lose work days. We have the vacation holiday shut downs coming in this first half. We've got the Thanksgiving, Christmas, we naturally do have a drop off, and again, I guess we're seeing some indicators, frankly, that have been dropping off again here recently. Things have not--it's not sustaining on an upward trend. Things are leveled off flat. We've even seen a couple things down tick. So, I think we're, we're hoping at the end of the day we're going to prove that we were conservative, overly prudent, but then again there are definitely some signs that concern us here and there.

We talk about the some of the indicators dropping off, you talking about internal Parker Hannifin IE orders or are you talking but just on the macro side?

Well, the Parker Hannifin orders in particular again reflecting some of the macro. But yes, some of the markets, which were recovering and quite strong and so forth, we've seen a little bit them coming off of those, those increases, so I think it's, it's hard to call, that's the problem. It's just very hard to call.

We have good visibility, feel very good about the first two quarters we're giving you, but it's really--it's really difficult to protect--predict those Qs 3 and 4.

No, sure. I couldn't agree more.

On your realignment expenses, I was a little bit surprised that you're maintaining $50 million of investments in 2011--level with 2010. Is this something that you expect to recur going forward, IE should we be more (inaudible) restructuring expenses these kind of levels going forward and secondly could you maybe describe in a bit more detail where you expect to spend that money?

The--this is Tim let me just carry out. The--what we've said historically before the downturn is that you can always anticipate us probably incurring $0.10 to $0.12 of restructuring every year.

We feel that's, that's just the normal part of doing business and doing what you have you to do to run the Company over the long-term. We basically have doubled that here now through this downturn, it's going to be three years in a row where we have doubled that. Now, why, do you ask is this carrying over into next year? Because a lot of it, frankly it's not here in North America, it is in Europe.

As you know, things are, sometimes they take longer to get done and they can be expensive, but this is sort of the last round and we would, we hope to get it done this year and we couldn't, so it's going to rollover into next.

After next year, I think we should drop about we should drop down to half the rate you've been seeing through this downturn.

Okay. That's helpful. And just one final quick one. Other expense dropped off a lot. 3Q to 4Q just wondering--why that--why that was the case?

You're talking on a segment basis?

Yes. Q over Q, the other expense from 3Q to 4Q dropped off.

I have year over year. I don't have 3Q to 4Q.

Okay. We'll follow-up offline.

Okay.

We'll have to get back to you on that one I guess.

And our next question comes from the line of Terry Darling of Goldman Sachs. Terri, you may proceed.

Thanks, good morning, everyone. Hey, Tim, I'm wondering if you could follow-on you mentioned about $1 billion of free cash flow for FY '11. Can you take us through some other pieces, what are you assuming object CapEx, what are you assuming on working capital there.

Sure. In general terms here, we still expect that we can do a little, now there's a difference between our metric sort of and then the absolute dollars, but we've done a great job on our day sales outstanding, receivables, we think there is a little bit more room to improve on that. We've done even better job in inventory but a lot of that is really a function of your cost of goods sold that you're calculating, but once again, we think we can do better there. We think, again, some cases these dollars will go up, but as a percent of sales improve. The one thing we did this year which, a tremendous job on, is in the payables area, and that helped a lot in the working capital and we definitely think there's some more room there.

So, that's kind of the three major components on the working capital. On the fixed asset, we think we'll get back up next year to a level where our, our Capex expenditures are pretty well equal to the appreciation, which is around 2.5% of sales. That's where we were before the downturn. Everyone pulled the horns in with the downturn, and I think this last year we only spent 1.2%, 1.3% of sales.

But, I think it will get back into a balance type situation of 2.5%, which is far below where we historically would run through an expansion, but that's what it looks like.

And depreciation, amortization all in, Tim, is that similar versus next year? Versus last year rather?

Yes. The dollars, they're very close the same, the big difference is the actual payouts on CapEx will pop up again to, to around that level.

And that Capex is what, $250 thousand, $270 thousand, something like that?

That is correct.

So, the free cash flow you call, that must be before CapEx, huh?

The way we get measured around here is cash from operating activity is less that CapEx, that's how we do it. We exclude dividends.

Because sometimes our investors get sensitive, they think we're going to take a bad decision to hurt their dividends. So, we leave the dividends out. So, it is cash from Ops less Capex.

Okay. I can follow-up on that.

And then Don I wonder if more broadly you can address kind of more the secular side of the growth outlook, not for just '11 but just longer term, going back a couple years ago to the analyst meeting where you talked about accelerating organic growth.

Maybe talk a little bit about how you're feeling, where you think you're gaining market share. Maybe talk a little bit about the, around the guidance on international, industrial, revenue growth for the regions, and just maybe talk about where you think Parker Hannifin's differentiating itself versus the market from an organic growth perspective?

Well, maybe I'll start just talking a little bit about the regions the one area that's still pretty soft for us is Europe. Okay?

We're recouping, or recovering pretty well in North America. If you look at our 2008 levels, we're almost at about 95% of 2008 looking at 2008 as being a peak so. So, I think we're doing well in all other various markets that we serve in North America.

In Europe, it's lagging. There's no question about it. Europe right now is at about a 80% level compared to the peak. Now that's up a little bit from the last couple of quarters that I've been talking to you, I think we're in the 70s and now we're just in the low 80s. So, I think Europe's got, has a long way to go.

I'll comment a little bit on the ISM indices here for Europe in a moment. So, I think that's one of our challenges. I think if we can recover more in Europe this year, think we're going to like the, the outcome that much more. The two other regions where I think we've done a good job and are penetrating and growing market share and so forth is Latin America. We're over 100% in Latin America compared to our peak year of 2008, and we're over 100% in Asia as well.

Of course, a lot of activity going on in China. We're still very active there. We're building up a broader foundation in India.

So, what we look at right now is the BIC countries more so than the brick countries if you will. We do have a presence in Russia, but we're going slow there just to see how that develops.

But elsewhere, I think we're doing a nice job of growing the business and penetrating market, and growing globally--the little bit of softness, and Tim kind of hit on this earlier, is, when we look at some of these indices you know the ISM index is down a little bit, and of course, still being pretty comfortably above 50. We're still--still feel pretty good about it. It just dropped a little bit. Likewise, in Europe it dropped a little bit as well.

When you look on the positive side, when I mentioned the negative side of Europe is that we're down, but on the positive side, all the major countries look like they're improving now from an ISM standpoint as, and we track all of these for all the major countries throughout Europe and that would include Germany and UK, and France, Sweden, Switzerland, what have you. So, all these major countries now, really are coming back gradually, but they're positive movement. So, we're encouraged by that, but again we need to see a lot more because Europe certainly did drop a lot more than North America and it stayed down a lot longer.

I think as far as our internal development efforts, we've got a very aggressive program internally here what we call win-ovation, as far as innovation and we have a lot in the pipeline if you will, and that holds true across all of the groups. You'd have to really come here to see all the things that we'll be showcasing a lot of this for our board this coming week at our board meeting, a lot of very interesting projects going on internally that are going to be coming out of that funnel and adding to our sales and our growth going forward. So, I'm very encouraged about that.

I think everyone on the call knows that we've made great strides in the aerospace side of our business. We won about $18 billion now on contracts in aerospace, so we've done a lot of great work there. Of course, at the expense of margins and our margins have been compressed because of all the non-recurring engineering that we're investing.

But again, we're investing in the future of the Company, so I think those are, those are some of the points I'd make. I think our internal development programs we're trying to fund those at higher levels that we can continue to generate more internal or organic growth for the Company going forward. We have a target--target of 4% coming out of our funnel, which would represent either new to the industry or new to the world type products, and we're probably at about half of that level right now. And so we're going to continue to work that until we can have that be an additive 4% of sales organically coming out with that definition.

When might you expect that to be able to get up to that 4% range?

I would say we've got a few years here yet. We're probably at--probably at 2% now, just in the twos, and I would say in another two, three years we should be at that 4%.

Of course, these things, when you say innovation and you snap your finger, it takes years to develop that kind of a pipeline and we've been working at this now for about five years so I'm happy that we are as far as we are, and--but we can see how we're going to get to the 4%, there's no question about it and that's--that's of course, higher margin business.

When you talk about new to the industry, new to the world, you don't talk about a lot of competition there at least in the early years, so this should be better business for us. Higher margin business, and truly state of the art type of products coming out.

And then just lastly a clarification on your geographic comments industrial international high end of the organic, or high end of the revenue guidance range, 4.5%, pretty fair to say Europe's pretty flat in that context?

That's right.

Thanks very much.

I can give you a little bit of color here on the order trends. Of course, we look at order trends all different ways here, but I'll give you a little idea. On the 3-12 and a 12-12 when we talk about 3-12 we're talking about the last 3-12 orders, last three months of orders, over the prior year the same three months, so that would be the index that we're talking about in a 12-12 would be the same, the last 12 months of the previous year the same 12 months, that ratio.

So, strong or increasing trends would be in industrial North America, Europe as I mentioned. Asia and Latin America, North American distribution, both of those trends are positive, and looking strong. Heavy duty truck, of course, and I think everyone on the call knows about heavy duty truck looking pretty good.

Refrigeration, semiconductor is strong but again I think they're probably at the peak, hovering around, bouncing around the peak of the level--highway level. How long we'll stay at that level the jury's still out there.

Aerospace is positive, especially on the commercial side of the aerospace business and off-highway construction. The one flat area on a 3-12 and 12-12 would be off highway farm and ag on a sequential basis, month to month that seems like it's improving, that would be a little bit of how we look at the orders on a 3-12, 12-12 basis.

I'm just going give you a quick run down to show you, that hey, there are positive things going on out there. I don't want anyone leaving this call that there is gloom and doom by any stretch.

On a sequential basis, now these are sequential order changes month to month, this year versus last year. These are the positives. Commercial aerospace and OEM and aftermarket and I think you know the revenue passenger miles are still hanging in there pretty nicely so people are flying. Military OEM still positive on a sequential basis. Cars and light trucks, those levels now are going to be around $11 million I believe this year, which is up 30% some from last year. Construction equipment is sequentially positive, o oil and gas, farm and Ag I mentioned on sequential basis is positive, on 3-12, and 12-12 didn't look as good.

I think that's coming back. Most of the general and industrial markets are good. Heavy duty trucks, sequentially strong. Distribution is strong--mining. Residential air conditioning and machine tools, powergen, industrial refrigeration and (inaudible). Those are just kind a handful of various markets. We serve hundreds of markets here, but those are some of the segments that would be positive sequentially.

Negative would be Marine, and certainly some of the military aerospace aftermarket businesses is, is negative on a sequential basis. Then, I mentioned before, flattening would be the semiconductor and the commercial air conditioning and refrigeration part of the business, so maybe that will give you kind of a little picture as to how things are looking.

Still positive and we're hoping that we can continue to build on this going forward.

Okay. Thanks very much.

Sure.

Thank you.

And our next question comes from the line of Alex Blanton of Ingalls and Snyder. Alex you may proceed.

Good morning.

Good morning, Alex.

Just like to echo the general theme here and observe that you had a 26% sales increase in the quarter, but really it was still down 8% from the average for fiscal '08. And if you're only assuming 5% or 7%, whatever you want to call it for, for this coming year, you're still going to be down below '08 with that kind of increase, including whatever acquisitions you've made since then, so it is a very, very conservative forecast. Can you just elaborate a little bit more on what you, what are the uncertainties you see for fiscal, the fiscal year we're in and perhaps calendar '11 in total?

Well, I think I mentioned the one area that's been down the most that we're waiting to come back is Europe. So, when you look at a whole region, that's $3.5 billion to $4 billion of our total number, that's the one area that we're waiting to see exactly what's going to happen and how fast that's going to come back, that's 80% of what it was in 2008. Most of the other regions have recovered, not entirely in North America, but moving in the direction. So, I say that, when you say concern, the question is, just how fast will your Europe recover, and this fiscal year. I would say that's the biggest area that we're watching very closely. A lot of the indicators are positive. Like I mentioned, a lot of ISM indices and so forth, but do I want to see that translate into positive, orders?

Alex, this is Tim, if I could sort of step up to a more macro level.

So, what I'm hearing out there and I was even in New York at a CFO conference and speaking to a lot of COOS not just in machinery/industrial but the whole, all sectors and it was pretty much universal, and the issue is that nobody knows what's coming.

We, people haven't even sorted through this healthcare legislation to understand what it means to them financially. We're talking about cap and trade on energy, again, and no one knows if that's going to happen or not. No one understands what they're doing on income taxes and are we going to let the bush expire, are we got to put the bush in, are we going to change other things. Now, buried in some of these bills is some very terrible legislation if you're a multi-national company. It is, it would severely impact those companies who have a significant percentage of their business offshore, which we do, which is, sort of in a strategic comparative. And I can go on and on.

So, we don't know, that's the thing, and so until, until people have, people cannot be optimistic or confident, what you need for recovery is sustained recovery. People cannot be optimistic or confident until they have some certainties that's the one thing markets hate, and we don't have certainty and so first of all, we have to have certainty. We've got to give people confident and they've got to then want to go borrow money and of course, the banks have got to loan them the money, which isn't an easy thing for a lot of people.

So, I mean, it really, there are some macro, there's a macro overhang here that has us all perplexed, and the--and frankly the relationships between business and Washington now are the worst I've seen them in 42 years. And I, everyone I talk to says the same thing, and so that's the problem. That's the overhang. If you guys can give us some certainty out of Washington, and I'm not saying about what--which way I'll vote on an issue, it's just that there's nothing certain, and we never know what to expect week to week, and so that's the atmosphere we're dealing in, Alex.

Listen, I appreciate those very candid comments that helps a lot. In looking at your markets this quarter, do you have any estimate or ballpark number on how much of the sales increase is coming from lower inventory reduction on the part of your customers or dealers versus the year before? In other words, if your dealers reduced inventory less this year than last year, that would translate into a sales increase for you. So, how much of the 26% is from that factor by itself? Do you have any idea?

There's still, Alex--there's still short lead times out there today, so I don't think that we're looking at anybody restocking or destocking or anything with respect to--at least, I don't see that. I think they're acting prudently in their stocking in accordance with the level of demand that they're seeing, very cautious. We're getting orders shipped tomorrow type things because people aren't putting a lot of inventory in. I think the demand that we're seeing is real demand. It's not a function of people putting a lot on the shelf without any demand out there.

They're being very cautious. They don't want to get hurt in this upturn if this tends to slow down.

So, I don't see any of that. I don't see any of that at all.

Okay. And final question is, I guess for Tim because Tim mentioned that normally you'd expect a 30% incremental operating margin, but that would only be within a certain range of volume, would it not? Otherwise, you would approach 30% total asymptotically over time. You can't keep that up. At some point it has to go down because,I'm sure the 30% is not the target for the operating margin. What is the target for the operating margin?

That's a good question, Alex, and I think you're right, I mean, as I said earlier, you can start on the up or the down, you can start with like [50], plus [50] or minus [50] and then it will fade to the 40s, 30s. It goes on long enough, it can get to the 20s of course, you're reverting.

Yes.

But, the target on the operating margin we've said is 15%. And now, we're trying to do 15% over the cycle. We've, analyzed that--in order to get 15% over the cycle we have to do a couple things. First thing we have to do is, in the good days, not stop at 15%. We have to get to 16% or 17% in the good days, and then in the bad days, we don't want to below 12%, let's say, all right. So, you raise the sealing, you raise the floor.

Now, that leads me into something, I'm very glad you asked that question because it's all about managing cyclicality, and we talked to you before that we thought we were prepared in the downturn and that we were not going to fall off the cliff like we did before.

Interesting, I just want to give you some statistics here. I went through this period here, so okay fiscal '08 was a boom year--great year. '09, '10 were really tough. '11 we're looking for an improvement coming out of it. And just, I went back and compared the same comparable years from the last downturn, and that would be fiscals '01, '02, '03, and '04. '01 was still a boom career. '02 and '03 were struggles and '04 was a recovery.

When we went into--in '08, that boom year, our operating margin was 230 basis points higher than it was in '01, which was the boom year before that downturn. We started that, we were at 230 basis points better. In '09 when we went down, we did go down, we went from 119 to 88, but you know that was 320 basis points better than the first year of the downturn the time before. This year '10, the second year of this downturn, we generate 10.4, that's 450 basis points better than the second year of the downturn '03.

And now, of course, we're looking at the recovery and we give you an up year, so I think that we've been talking about it. You can talk the talk. You need to walk the walk.

I think that we have done that, and I am so proud of our people that they have been able to raise the ceiling, raise the floor. Anywhere from 230 to 450 basis points. So, I think it is--we've got to keep going, and you can't raise the ceiling if you don't raise the floor. I think we've done that. We've proven that, so hopefully onwards and upwards, but like I say, right now we're pretty, we're pretty confused out here.

Well, yes, back to back over $3 a share here, pretty good. That's the lean strategy. Win-strategy, lean, right?

Lean is embedded--lean is absolutely embedded into the win and the one last thing we talked about cash, and I would just again, just the five years of the expansion '04 to '08 our cash flow from operating activities were 10.0%. That's what it averaged, 10%. These two years, these horrible years, the worst we've seen they've averaged 11.6%.

Terrific. Okay. Thank you.

Thanks. Thank you. Who do we have next?

And our next question comes from the line of David Raso of ISI group. David, you may proceed.

Hi, good morning.

Good morning, David.

We understand you're basically saying, "look, things are okay right now. We don't want to take any stance on a strong guidance, but just so I understand, you're 48, 52% revenue split. The first quarter, if you look at the recent order trends, if you're looking at revenue's up near 30% for the quarter, that half year split is saying then the second quarter revenues are down 9% to 10% year-over-year.

Now, I understand the idea of just giving a conservative guidance, but Don's comments about the next six months we have good visibility, the guidance is telling you second half revenues--I'm sorry, second quarter revenues year-over-year are down.

How is that consistent with a company looking to double their CapEx in a year. They're talking about a billion and a half of M&A power. I'm just trying to square up the commentary. It is what it is. You're just giving a conservative commentary.

David, this is Pam Huggins talking. Just to clarify numbers a little bit, and let's talk on an organic basis. When you look at first half of 2011 versus 2010 and I'm talking at the midpoint of course, you're about 14%, you have a 14% increase.

When you get to the second half, you're still almost at a 2% increase. So, we show a huge increase in the first half. The second half is relatively flat with the first half, but on an organic basis it still is an increase.

True, but again the second quarter, if, last, last quarter orders were up [23]. You booked revenues up [26]. Quarters were just up [35], let's trim it a bit and say revenues were up only 30 in the first quarter that means the second quarter revenues have to be down year-over-year to be consistent with your [48], [52] split and that's fine. You could be saying we don't have visibility beyond 90 days, which is fine, we're a bit of an uncertain time on the macro data versus what you're seeing on the ground. But, I'm just trying to square up, how you're thinking about--I know it's getting back to depreciation, Tim, but you are looking to double your Capex in a year where you think beyond 90 days your sales are down. I'm trying to square everything up here.

David, again I'm not seeing-- .

Second quarter organically we're up 9%.

So, second--so, second quarter's up nine, you're saying this coming quarter is more like [19], despite orders up [35]?

That's right.

Okay.

But let me tell you that 35, you have to remember, it's against tough comparisons and if you look at the actual orders, on an absolute dollar basis on a three-month rolling sequentially, last quarter to this quarter, that's not the type of increases that you see, David. So, you do have to remember that there's some really--you're up against tough comparables.

And then when it comes to the end markets, you're typically about 90 days X the aerospace business, but when you actually look at what the Cats of the world and Deere's and the wide variety of other non-mobile bases,all the industrial markets, life sciences, everything, are you seeing, and I know those production schedules could change, but obviously a lot of your customers give you beyond 90 days with some framework, are you seeing calendar fourth quarter production schedules that are only equal to or up modestly from calendar fourth quarter '09?

Well, what I can tell you is when you look at the markets in the mobile and you look at it on a sequential basis, it's up high single digits.

David, this is Tim. I'm really struggling here, because I, it's just, what you're saying and what we've got here, because without giving the-- I'm seeing a first quarter next year forecast of, first quarter next year that is up considerably, $400 million or so over the Q1 of the prior year.

I'm seeing Q2, of next year being up like $300 million over the prior year, and I'm seeing Q3, being up a couple hundred million over, and then I see Q4, of next year not a whole lot different than the Q4 this year. But, I've got all the very strong increases year-over-year.

But,Tim, the full year revenue guidance is only up $500 million.

Sequentially, sequentially, I'm talking the year--sequentially, if we're going off the fourth quarter of this year to the first quarter of next year, yes, it's down a bit. It is down a bit. And that's simply because of the--the summer months of vacation shutdown, so anyway.

But remember, David, currency's in there. I know you know that.

No, I appreciate that. But it just, between, revenue guidance for the year all in is up about $500 million, and you were rattling offs hundreds there year-over-year where--

I did.

There's got to be a negative number there somewhere in the guidance. Look I know it's--if you're just doing the crystal ball thing, "we don't really know beyond 90 days." I'm just trying to square up how that's going was your decision on Capex. I know it's getting back to depreciation, but you're doubling Capex. You obviously have an acquisition pipeline that's--when you read between the commentary, it sounds like we're looking to step up acquisitions. You haven't gone this many quarters without making a acquisition--I don't know how long. It's been at least a tech aide.

Right.

I'm trying to make sure this conservatism doesn't actually parlay into you just sitting on a balance sheet that should be utilized right now or, really, alters how you're thinking of your production schedule. I'm thinking commentary versus you in practice.

No, as I said again, the numbers I given you were before the currency impact, which I think Pam gave you which is built in and is significant. No, and as you know, when we said we are looking at things again, we have a strong balance sheet, we have capacity, and we're looking at things again. But, we're going to be very disciplined on what we, what we look at and what we think about acquiring.

Just one last comment. The M&A environment, Don and Tim, you are still looking at it as these are the parts of the cycle where Parker Hannifin utilizes the balance sheet.

Right.

You're not taking your macro view and sitting on your wallet per se?

Yes, that's correct.

Okay. That's helpful. I appreciate it. Thank you very much.

Thank you, Dave.

And our next question comes from the line of Steve Volkman of Jefferies & Company. Steve, you may proceed.

Hi, Steve.

Hi, good morning. I think most of it has been answered, but just anything in the 2011 outlook with respect to raw material trends? Any supplier constraints or pricing issues that you feel like we should comment on?

Well, this is Don, the, we're still getting pressure on some raw materials side. Say, the ones that would come to mind would be copper, and rubber and steel, some of the thermal plastics and nickel and things like that, nickel based alloy.

So, that's an ongoing thing, Steve, I don't see that we're probably going to get much relief, and as this continues as the economy continues to grow, I think that will just continue on. What we, our goal is to pass it on, basically is to--we negotiate the best we can. We push back the best we can.

We do the best we can on the procurement side, and then of course, we've got to make it up on the other side. And, I think our performance over the last 5 to 7 years proves that we understand how to get that job done, so I don't anticipate that we're going to have any--Parker Hannifin have any major shortages or anything like that going into this period, but I do think that there's going to be more pricing pressure going forward.

So, net of price, or the price cost balances is that a net positive for you?

I'm going to say we're going to at least--we're going to at least offset. Let's put it that way, we'll offset any cost increases with our pricing.

Got it. Okay. Thanks very much.

Thanks, Steve.

And our next question comes from the line of Eli Lustgarten of Longbow Research. Eli you may proceed.

Good--Good morning. I almost said good afternoon at this point. Thank you. Quick question, I want to make sure clarification because,Tim, didn't you say initially that you forecast the first half and then you really treated the second half as flat adjusted to the number of days, so anything could happen in the second half as far as guidance goes. I think that's the part we're missing

Yes, that's exactly right. I think as Don pointed out earlier and we tell you that we have other bites. We'll have other opportunities to come back and re-calibrate this thing. But, right now--we are, that's our issue. Our real concern, Eli is Q3 and Q4.

We shouldn't say if you have a $1.50 and wind up $3.40. If you have a [60] at the bottom who knows where we can go to. I'm kidding.

$8 right?

Right. In the order patterns that we've shown for the power business, how much of the gain was in distribution versus OEM? I mean, are they up equally or is there a big difference between distribution and OEM?

Well, if you're talking about on a sequential basis? Distribution is, I would say, high single digits.

Yes.

And it's pretty much in line, we're pretty much seeing that going across industrial as well as mobile.

Yes.

When you look at it on a year-over-year basis. Obviously, mobile is up a little more than distribution and the industrial side of it.

We saw the industrial come back very strong. And then it, it kind of flattened down. And then, we saw the mobile take a big leap forward. Now we're starting to see industrial come forward in Europe.

I guess I'm trying to get the split between distribution and OEM business or so and the bulk of the game right now is coming from OEM as opposed to the distribution system.

That's right.

Yes.

That's fair, and can you talk a little bit about aerospace. You were starting to see a lot more activity in aerospace and seeing potential for double digit gains. You've got modest gains next year for aerospace, and you have margins not doing very much in the backlog.

When do we start seeing some of the leverage from aerospace and when do we see some of this--how much of the increase in R&D going to be next year holding down margin, at what point do we see that crossover coming?

In terms of R&D, let me ask--let me just talk about that a little bit. We have a slight increase next year, not much in terms of the percentage of sales. R&D has been running around about 10% of sales, and that's going to continue next year.

What is happening, though is commercial aftermarket and the commercial OEM that will increase next year. What's going to happen is we're going to have some decrease on the defense side. The C-17 and the F-22.

I'm sure you're familiar with what's happening with those programs so we're going to see some decline in the defense side of the business, which is going to be offset by the commercial OEM and the commercial MRO both will be increasing.

And there's a pretty good increase you know built in for the commercial aftermarket side, which you would expect as the revenue passenger miles are going up.

So, but again, 2012 that we start to see the break out in both revenue --

Yes.

And--return to more normal level of profit --

Yes, we think this R&D is going to continue to go down as a percentage of sales as sales continue to increase.

All right. All right thank you.

And, our next question comes from the line of Robert McCarthy of Robert W. Baird Robert, you may proceed.

Morning, everybody. Thanks for--

Good morning.

Thanks for taking my question. I'm sorry, Pam, could I just get a couple things clarified from the last two questioners.

I think I thought I'd heard you said that you though of R&D as a percent of sales would be maintained at current levels because you need to keep it up, but then I think right at the very end of your response, you said something about R&D going down a little bit.

Yes, let me clarify you. Fiscal year 2010 to fiscal year 2011 is relatively flat as a percentage of sales.

Okay.

So, a very, very minimal increase. But as we go forward after fiscal year 2011, we think that the R&D is going to come down as a percentage of sales.

Okay.

It's revenue climbs.

Okay. And then the other one was, at the end of your comment for the prior questioner, did you actually say that you're seeing improved order flow sequentially out of European distribution?

Out of European industrial. We're starting to see the industrial side of the business pick up in Europe.

Okay. But not, not distinguishing between distribution and OE.

No, because we're seeing, in all areas it's picking up. Whether you look at the mobile or the industrial or the distribution, all three aspects of the business are increasing. I'm just you talking relative.

Yes. Absolute numbers. Okay. So, then what I wanted to--what I wanted to ask about and sorry if this seems like beating a dead horse on couple of these issues, but I assume that, given how important pricing has been to the successfully overall Win strategy, that you are assuming some positive pricing contribution in your FY '11 guidance, or put differently, wouldn't you be assuming some cost inflation?

Well, yes, Rob. This is Tim, Pistell. There is a nominal--again, when we, when we roll it all up, because, of course, it's all very specific to the situation.

Sure.

But when you collectively roll it up, there is a modest assumption on price increase in there-- positive price increase, yes.

When, I mean, can you help me, Tim, when you're saying modest you mean less than a percent kind of number?

No. 1% to 1.5%.

Okay. All right. And then the other question that I ask with fairly transparent motivation is, is there any link between compensation and the accuracy of the forecast that you get from the operating units as you roll up your internal forecast?

Yes, none whatsoever, actually let's see our compensation, the key components one was based on cash flow. Another one is based on return on net assets--all actuals. Those are the two key short term. The longer term of the share price, and then sales growth, earnings growth, and ROIC and none of it, and it's how we do versus the peers. It is not how we do to a plan.

But, Rob. One of the things that I will say is at the group level the president and the group controllers, they look at the accuracy of that forecast on an ongoing basis.

Okay. But outside of, call it managerial situation, there's not really any explicit downside from submitting a forecast that later is trounced.

No.

No. Either direction, there's no incentive to, to go higher or lower as far as that goes.

Well, but Don said, you specifically want people forecasting numbers that you can be sure will be delivered.

Well, we want to have a high confidence that they deliver the operating margins and the EPS if you will, irrespective of what happens on the top line. We're going to hold their feet to the fire on getting to the bottom line. And, by saying that, I mean, early in the program, we don't want them it just hiring a lot of people just because they forecast, forecasted some high level top lines so now they can justify starting to spend money--bringing, hiring people, spending money and so forth as if we're running at that level. We don't want them spending money at that level until we get to that level.

No, of course, not.

Like Tim said, I think the important thing is, it's a good question that you asked, our incentives are tied to our performance against the peers for the most part.

Okay.

They're tied to the peers, so if we get into the top quartile of performance relative to peers, we're going to top quartile foreign incentive. And if we're in the midpoint, we're going to be about middle of the pack. We'll get the middle of the pack kind of incentive. So, that's kind of how we're basically incentivized here.

Thank you, Don. And then, if I can, there have been a couple comments made about, Tim you calculate an acquisition capacity. You talk about being back in the market. You're seeing more stuff, but in each case, when you've mentioned it, you've said something about we're going to remain disciplined.

Can we infer from that that you intend to remain more disciplined than you have been in the last couple of cycles? Or are you just trying to say we're not in any hurry. We're not trying to meet any objectives.

Well, what we're saying is, number one, there has to be a good fit--this is Don. There has to be a good fit with what we're trying to accomplish here. It has to be synergistic. And number two, is the fact that we don't like the multiples--where the multiples got to at the peak of the last cycle in 2008. We didn't like the levels that these properties are being sold at.

We're not going to pay those kind of levels. So, if we need to have a return for our shareholders based on a reasonable price of fair return and a fair price for the property. So, what I mean is, that you know, people are still looking in their rearview mirror thinking that you know those EBITDA multiples are going to hang in there forever, then frankly, we're going to do fewer deals at those levels. We're going to--and I don't think that we're alone in that respect.

Based on what I'm seeing out there, I think everyone's kind of looking at the same thing, that "hey, wait a second here. We're not going to have this euphoria as far as top line growth growing double digits forever and then that backing into some kind of discount of cash flow that gives you some huge valuation. Those are the times of the past," So, we're going to be disciplined, and we're going to be prudent--we're going to obviously going to go after the those things that have the most synergistic impact on the Company. But, we will not do it at any price.

Perfect, thank you, Don. Very helpful.

We can take one more question at this time.

And our next question comes from the Ann Duignan of JPMorgan. Ann, you may proceed.

Hi, guys, it's Ann Duignan.

They never seem to get it right for you. Do they, Ann.

That was the most bizarre, I think.

Most of my questions have been asked obviously at this stage of the call, but Tim I wanted to step back and just prod you a little bit. You compared margins cycle over cycle. '09 '010 versus '01, '02, '03. Can you tell us, with the odds like midpoint or the odds that you've given us for '011. How does that compare with '04.

I think it compares well, I mean '04 was a recovery year, and it was one that had been continued into '05 and '06, a little different, but it was--it was a nice uptick. It was around a 10% increase in volume in that case, and we picked up a couple hundred basis points on the operating margin. We went from 5.9% to 7.9%, Ann. This from--'10 to '11 we're looking at only a 5% increase not a 10% and we're picking up it looks like about 100 basis points. So, it seems to hang together pretty well that way.

Yes. To David Raso's question earlier. I think it's fine when you guys are conservative, and we appreciate you being conservative particularly in calendar year '11. But sometimes the numbers just don't add up when we go back to the drawing board.

So, I think that was the point that David was trying to make.

Can you talk specifically just also on pricing and the pricing environment in Europe in particular? Are you seeing any increase in pricing competition from European competitors just as volumes recover over there?

Ann, it's still pretty early, with the levels of activity over there right now. There's really no--not a lot of pricing, if you will, capability in Europe at these levels because they're very, very depressed yet, and I think that's going to continue until that activity levels pick up.

And is that a function of your more exposed to OEMs in Europe versus distribution or is it-- .

I think it's a function of demand. The demand is so low being at about 80% of the 2008 levels that--there's--the customers are not going to be taking any price increases for the most part until they see that their demands picking up and they can justifying accepting anything there and justifying it. If you follow what I'm saying.

Yes. Yes, okay, well I appreciate the color. I think most everything else has been answered so thank you.

And it's Pam speaking I'd like to say that our guidance is realistic as opposed to conservative, but and then just to answer a question for Nigel Coe. I think he was the one who asked about the other category, and why I didn't have third quarter to fourth quarter. I can deduct from the information that I do have that it's really mostly related to inventory valuation and currency and we can talk further offline about those two items. So, at this time I'll turn it over to Don to--with a few closing comments. And thank you very much for your participation today.

Yes. Thanks we extended the call a little bit because we got a little bit late start, so hopefully that didn't put you any pain with other calls that might be happening.

I think you can, you should pretty much agree that we're positioned pretty well as a company, you know, and have come out of this situation a lot stronger than we went in this recession.

I think in line with Tim's comments, I'd like to just reiterate the point that we've now increased margin performance at the bottom of each of the last three manufacturing recessions. And just as importantly we've also raised the peak margins at the height of each of the last two expansions.

And, I think that doesn't tell the whole story either because this last recession was the worst one in 70 years, so I think having improved the raised the bottom and raised the top in an ugly situation that we hadn't seen in 70 years speaks very highly for the Company. So, I think it all represents or demonstrates our ability to reshape the financial performance of the Company, and we've basically told you what we're going to over the last 5 to 7 years year here, and we're executing and we're doing exactly what we said we'd do. So, hopefully our credibility is pretty well out there. It's pretty good.

We're going to continue to excellent all aspects of win-strategy, I think you can see what's happening. We're obviously going to focus a lot on growth and profitability as we have. We anticipate in ongoing investments in R&D and international expansion. I've mentioned some of the Asian region as to what we're focusing on there. Acquisitions and distribution are also going to be a focus to grow our business going forward, so with that, once, again, I want to thank everyone on the call, and we certainly appreciate your interest in Parker Hannifin. I'd also like to thank, one last time, the Parker Hannifin employees across the world--and many of them are tuned in here--for their continued commitment to serving our customers, and then just as we said in the past, Pam will be available at the balance of the day to answer any additional questions that you may have. So, with that I'd just say good bye and have a great day.

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