Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Parker Hannifin Corporation Earnings Conference Call. My name is Anne, and I will be your coordinator for today's call. As a reminder, this conference is being recorded for replay purposes. [Operator Instructions] I would now like to turn the presentation over to Pam Huggins, Vice President and Treasurer of Parker Hannifin. Please proceed.

Thank you, Anne. And for those on the call, you know it's Pam Huggins. But at any rate, good morning. I'd like to welcome you to Parker Hannifin's Third Quarter Fiscal Year 2011 Earnings Release Teleconference. Joining me today is Don Washkewicz, President and Chairman, Chief Executive Officer and President; and Jon Marten, our Executive Vice President and Chief Financial Officer. For those of you who wish to do so, you may follow today's presentation with the PowerPoint slides that have been presented on Parker's website at www.phstock.com. For those of you not online, the slides will remain posted on the company's Investor Information website. Again, at www.phstock.com, and they will remain there one year after today's call. At this time, reference Slide #2 in the slide deck, which is the safe harbor disclosure statement, obviously addressing forward-looking statements. And if you haven't already done so, please take note of this statement in its entirety. Moving to Slide #3, this slide as required indicates that in cases where non-GAAP numbers have been used, they've been reconciled to the appropriate GAAP numbers. And again, they're posted on Parker's website. To cover the agenda for today, on Slide #4. The call will be in 4 parts. First, Don Washkewicz, Chairman, Chief Executive Officer and President, will provide highlights for the quarter. Second, I'll provide a review, including key performance measures of the third quarter, concluding with the revised fiscal year 2011 guidance. The third part of the call will consist of the standard Q&A session, which I know you're all looking forward to. And for the fourth part of the call today, Don will close with some final comments. So at this time, I'll turn it over to Don and ask that you refer to Slide #5 titled Third Quarter Fiscal Year '11 Highlights.

Thanks, Pam, and welcome to everyone on the call. The way I thought I would start this meeting out would be to just kind of take a look back at what we did last quarter, our second quarter, and then the guidance that we provided at that time and then contrast that with how we performed this quarter. So if you remember, the second quarter for Parker was extremely strong performance, with record sales and net income and earnings per share well ahead of expectations. And actually, if you go back even before the second quarter, if you look at the first quarter, the first quarter had a series of records as well. So this is -- we're going into the third quarter of the year, setting pretty much all-time records for the company. At that time, back in the second quarter, we anticipated that earnings for the year would be in the range of $5.80 to $6.20, or a midpoint of around $6, and that sales would increase greater than 17% and that the segment operating margins would be approximately 15% for the entire company, and that our marginal return on sales would be approximately 30%. So that's what we told you back in the second quarter, kind of giving you a little outlook of what was going to happen before the third quarter and beyond. So here we are, at the end of the third quarter. And I'm really very pleased to report that based on our third quarter actual performance and current outlook for our business, we are certainly on track. And in fact, we've increased our expectations for sales and diluted earnings per share for the balance of the year. I'll take just a minute now to review our third quarter results and to point out…

Thank you, Don. So at this time, if you would just reference Slide #6, I'll begin addressing earnings per share for the quarter. Fully diluted earnings per share for the third quarter came in at $1.68, which is an all-time quarterly record. This is an increase of $0.74, or 79% for the same quarter a year ago. Sequentially, compared to the second quarter earnings per share, if you remember, $1.39. This is an increase of $0.29, or 21%. Earnings per share for the quarter exceeded expectations. The vast majority of that beat came from operating income within the Industrial International segment. And obviously, the higher revenues contributed to that. Realignment expenses at $0.02 for the quarter, they were lower than anticipated due to delays in implementing the final arrangements with respect to a restructuring plan. And as a result, $0.05 of planned realignment for the third quarter moved to the fourth quarter. Marginal return on sales for the quarter at 28% is a little less than originally thought due to input costs and costs incurred in ramping up to meet this robust demand that you're seeing. But the plan is to be at 30% by the end of the year. Year-to-date marginal return on sales is 33%. While raw material headwinds continue to be somewhat of a challenge for us, Parker remains focused on recovering them and expects the fourth quarter to be strong, producing an all-time record earnings per share for the quarter and the fiscal year. It should be noted however, and we've talked about this a lot, but as this cycle progresses, incrementals will decline. We're starting to see this currently as operations continue to ramp up to meet robust demand, with sales greater than prior peak. And you can see that sales were greater than we…

[Operator Instructions] And our first question comes from the line of Jeff Hammond with Keybanc Capital Markets.

Yes, just, I mean, hitting on the incrementals, can you just update us? I think last quarter, you talked about price costs, ramp costs and some of the issues holding back incrementals. And can you just talk about progress in terms of getting those under control or getting pricing through and how that might play out as we go forward?

Jeff, this is Don. As far as the prices and the costs, I guess I can talk about both of these. There's more to just the price/costs relationship with respect to incrementals. But right now, as you know, we've had a considerable number of price increases over the last six months or so. We started in October. We had one in January. We've been passing through surcharges after that point in time in February and March. We don't have all of these in yet as far as totally received, because we never price ahead of our costs. In other words, we're not going to get price increases if we're not seeing major cost changes in alignment. So we're always going to be a little bit behind. What's happened of late is that -- of course, we have some of the commodities now that have ramped up pretty drastically. I think everybody's aware of oil, what's happening there. It's up to about $113, I believe, a barrel. Castings are up, steel bar's up. When you talk about some of the metals, aluminum and copper and nickel and even plastics, are up quite a bit. The biggest drivers have been oil, steel and copper. Copper, I think, is at around $4.50 a pound, if you can believe that. It wasn't that many years ago, it was $1 a pound. So what we're doing is we're doing exactly what we've done in the past, exactly what we've done coming out of the last cycle where we saw a lot of inflation. And that was to stay on top of it. We've got our teams that are managing our purchase price index and our sale price index and making sure that we're recovering the cost increases that we're seeing. Of course, you're going always…

Okay, great. Thanks for the color. I'll get back in queue.

Thanks, Jeff.

And our next question comes from the line of Andy Casey with Wells Fargo Securities.

I guess, just to revisit -- and I don't want us to go through everything you just did, Don, but in the last quarterly conference call, you gave out this reacceleration target on the MROS. And a lot of things have changed that you just went through. You've touched on adding back labor costs, and I'm wondering if that is something changed from the outlook that you had at the end of fiscal Q2?

Well, we obviously have to add back in direct proportion to the activity levels. So yes, we've added back more than what we planned on because our sales are higher than what we planned on. So that's certainly something. But I have to also say in full disclosure here that our productivity levels are -- based on the numbers I have seen, are higher than they've ever been in the history of the company. So we haven't -- it's not like we've hired everybody back that -- we had all these cutbacks over the last couple of years. We are performing on extremely high levels of productivity. And obviously, that's helping our margin quite a bit as well.

Okay, and then kind of if I step back from what you went through and the 30% going more to the sustainable 20% to 30% range on MROS as we get further into the cycle, implicitly, that suggests lower improvement in operating margins. So from here, is it in your mind that Parker is more of a revenue growth story supplemented by acquisitions? Or how should we view kind of the future for this cycle?

I think that we're still -- our target still hasn't changed. It's really 10% growth, 12% on the outside as a stretch for the company. Of course we're doing more than that this year. We'll probably do more than that next year because you can just see the way the orders are coming in we're going to have another great start going into next year. So I don't see anything negative based on MROS. If you look historically -- and matter of fact, I think our MROS is matched up pretty good with everyone else's MROSs out there. Matter of fact, I think we might be the highest of the pack when you do a comparison. So even in a 20% to 30% range, we can continue to improve margins throughout the cycle because we're going to be generating MROSs that are higher than our average margins for the company. So all of that bodes well for margins going forward. Of course, there's a theoretical upper limit. But one of the reasons why we target 15%, I mentioned earlier, is to be in that top quartile. But we don't want to destroy shareholder value either. So if we don't want to pass on opportunities because we're trying to squeeze more margin out of the business and pass on opportunities that would add to shareholder value. So when we look at 15% and we back into return on net assets for the company, 15% is a very, very robust -- gives us very robust return on net assets that are very accretive and very good for building shareholder growth, or shareholder value, rather.

Okay, thanks. And just one follow up. Could you touch on the acquisition pipeline?

Sure. Acquisitions, we are actively looking for acquisitions. We've expressed interest in a number of companies. We probably are looking at a dozen right now, somewhere thereabouts. We've expressed in -- have expression of the interest out on several. Due diligence is in process on others. We're looking closer at some where we've been invited in for a second round for instance. Of course you know that they have to have a synergistic and a strategic fit for the company. That's the first priority and the first thing we look at. And I would just say that we're looking across all of the groups in all the technologies in the company and all the regions. So it's not just focused in one region or another. We're really looking throughout the entire corporation in all segments of the business. And the good news is that we've got plenty of capacity. When and if we find something that we like, we've got the capacity to do it. So we are very active. There's a lot of activity going on out there. I just don't hear of a lot of deals being done though, frankly. I mean, I hear a couple of big deals in our space, but I don't hear a lot of the kind of size deals that we're talking about going on. Here's a few here or there. So I think everyone's kind of in the same place. Prices are high typically, so if you don't have synergies that you can bring to an acquisition, it gets tough to justify in a reasonable time horizon. The prices that -- the EBITDA multiples that people are expecting out there. The question is whether they're going to get those kind of multiples long term. So from a strategic standpoint, we're always looking for strategic acquisitions. We should be able to capture whatever we really want to go after out there because we would have the synergies that come into play. Hopefully, that answers the question on acquisitions.

And our next question comes from the line of Jamie Cook with Crédit Suisse. Jamie Cook - Crédit Suisse AG: Not to harp on the incrementals again. But just, I mean, Don, it sounds like you're saying that the new run rate is the 20% to 30%. And I guess is, I think, longer term, is the correct way -- I feel like what's impacting Q3 and Q4 is more sort of -- we had Japan, who could have forecasted that? We had price costs, which hopefully we catch-up on. So I mean, is it correct to say that -- I mean, can incremental margins theoretically accelerate from -- in the short term at least, earn in the beginning of 2012 from these levels just because a lot of the stuff is more sort of onetime or Japan or things like that, that's sort of hard to forecast?

I think that if you just take 20% and say we finish at 15% as a company, any additional volume that we generate next year is going to have upward pressure on the margin. It's just the order of magnitude that we're talking about here. So again, at early parts in the cycle, and if you look historically, there's nothing that we're doing here that's much different, other than that we're being very thoughtful about managing to make sure the groups aren't bringing back a lot of additional costs that is not justifiable at that part of the cycle. We're trying to manage it very closely. So none of what's happening here, none of what we're doing with respect to MROS development, is anything new. I think, if you look historically, you'll find that as the cycle goes forward and as your sales have increased dramatically, the incrementals are going to drop a little bit. But that's normal. I won't look at that as anything outside of that. When you look at the fourth quarter, I think our implied guidance, Jamie, is $1.73. And that's coming off of $1.68 third quarter. Now keep in mind, there's about $0.05 of restructuring in the fourth quarter that's been pushed into the fourth quarter. So that's in the $1.73. So that suppressed it by about $0.05 already. And we talked about the Japan impact -- and keep in mind that the third quarter was an all-time record. So I think the guidance -- I think that it is going up. It is reasonable at this point. And certainly, there is upside in our range if we come in better and come in stronger and we get all the surcharges that we expect to -- hopefully, we can get. There's certainly some potential upside for this higher end of our range. Jamie Cook - Crédit Suisse AG: And then just a follow-up question. I mean, your orders continue to be exceptional. Can you just sort of talk about the visibility that you have today into 2012, relative to sort of where we were sitting last year?

Well, I think that from an order standpoint, we can probably see into -- certainly through the first quarter of next year, across our Industrial businesses for sure. And on the Aerospace, we're at about -- was it 18 months now? It was around -- about a year and a half on the Aerospace side of the business. Keep in mind though, and I try to make sure everybody understands this, that it's not just our hard orders that we're receiving today. We have as much visibility as our customers have, okay? And what we're doing is getting inputs from the customer on a realtime basis. So right now, I'd have to say that the feedback we're getting, pretty much across the board, across all regions, is very positive, coming back from the customers, going, extending on beyond the first quarter of next year. And in fact, I suspect that what we're going to probably see is, especially since it's going to be an election year, is that next year is going to be a very good year. And then going into 2013, we're probably going to have very nice numbers and nice performance for the company. Matter of fact, our whole industrial sector is probably going to do very well throughout next year. So that kind is our take. We've got visibility on orders certainly through the quarter. At the end of this fiscal year and into the first quarter, with the strength of these orders, we can see way beyond that, especially talking to the customers and getting their inputs. Jamie Cook - Crédit Suisse AG: All right, thanks, I'll get back in queue.

And our next question comes from the line of Joel Tiss with Buckingham Research Group.

I'll finally take the questions in a different direction. I wonder if you can give us a sense of why the account receivables are up so much? And even on a cash flow basis, you're running on a free cash flow, about $150 million behind where you were last year.

Yes, I can help with that, Joel. One of the things to remember is DSO is consistent with where it was prior year. It's just up on a sequential basis. And the reason is -- it's kind of a difficult explanation here, but it's not a function with anything in the portfolio. It's a function with the calculation. Because in the December quarter, most of your sales come in October, November. So you have time to collect some of those receivables. When you get into March, a much larger portion of your receivables come from that March quarter. And because we calculate DSO based on day sales -- the average days outstanding versus the receivable balance at the end of the quarter, it's really just a function of the calculation. Now receivables is using money on the cash flow statement, obviously because of the robust demand in the growth. And March is a very good quarter for Parker.

Are we going to recapture that before the end of the year?

Oh yes, yes, yes. Absolutely. Like I said, there's nothing in the portfolio to be concerned about. It's just a function of the calculation.

And then second, just a philosophical question. Can you talk a little bit about share buyback to offset the option dilution versus your acquisition opportunities? I know Andy already asked you about acquisitions. But just sort of how you're thinking about that? Are you seeing such good acquisition opportunities that you're not really focusing on buying back any shares?

I think that's true. If you look at our priorities, Joel, obviously, the first priority has been dividends. And we've indicated that. You've been able to see that, I should say, over the last five quarters. We've hit it every quarter. We're really trying to drive that up to a medium kind of level. We were a little bit low. We want to get to about a 25% payout over time. And I think, you can see our efforts are in that direction. So that's goal #1. Number 2 is really the acquisitions. And we definitely want to do acquisitions. We've stated that. We'd like to generate about 5% of sales coming from acquisitions. And there's plenty going on right now that hopefully, some of that we'll be able to bring in over the coming months going forward. The other area that we want to invest in is in the rest of the world -- is where a lot of the growth is certainly coming from right now. And a lot of the infrastructure requirements for the company are going to be is in places like India and China and Asia in general. And so some of our capital is going to be spent in that area to help support the high growth rates that are happening there. Likewise, when you talk about growth, of course we'll want to continue to fund the innovation. I might point out, too, that a lot of the groups are funding innovation through their P&L at much higher levels than they were before. Our innovation now is probably 3.5% invested overall as a company. Of course, you know the Aerospace is 12%. And when you look at these margins, just keep in mind that we're funding a lot of the innovation and R&D expenditures…

And our next question comes from the line of Nigel Coe with Deutsche Bank.

So Don, I just want to return to this MROS question. I'm a bit perplexed that there's so much focus on this as a problem or an issue when you're one of few companies that have reported so far that haven't seen a deterioration from 2Q into 3Q in MROS. Secondly, the 28% is actually one of the highest you've seen. One of your peers this morning did 21%. ICW yesterday did 22%, I believe. Why do you think that this is such an issue for you guys? Do you think you're too explicit with your forecast? And do you intend to change the communication going forward?

Well, that's a very good question. I think everything is relative. And I'm glad you made those points because we've seen some of those same numbers that you're looking at, Nigel. I think that, because we talked about it a lot into the downturn -- and we really -- it's on the Win Strategy. It's been in the Win Strategy for 10 years. If you look on the back of the Win Strategy, we've got 30% MROS on there. But we really talked about it a lot more in this downturn than we've ever had before, because what we're really trying to do is to manage the cyclicality of the business, okay? We told the investment community. That's what we're trying to do, is become less cyclical. So what that means is that we've got to do a better job throughout the cycle in managing the amount of drop off we have and incrementals at the low part of the cycle. So when we started talking a lot about that, I think we got a lot of interest and a lot of attention. And I think a lot of analysts started looking at MROS. And so that's really what got us to take hold. I don't think we should shy away from it. It's just that I don't think it should be over -- I think we shouldn't be overwhelmed by too much discussion on MROS. I think we need to -- it's a better metric going in the downturn than it is really going forward. I'd be much more focused right now on absolute margins for the different segments of our business and what's causing margin changes than I would be getting overly concerned about MROSs. So I do appreciate your input though, Nigel, because we've seen some of the same things. And I was really concerned, frankly, after the second quarter presentation that we made and the spectacular results we had for that quarter on top of record first quarter. And then I saw the reaction on the street and I said, "Oh my God, what happened here?" And I think a lot of it has to do with this MROS and the way people are interpreting it as something doomsday or whatever. I'm not sure just what they were thinking. But I think that really caused some angst out there in the financial community, and it settled down finally. But I would say, use it as a metric not a -- it's not the most important thing we look at around here. It's RONA, it's return on sales, operating margins. That's really the more important things.

Oh, I fully agree. Now having said that, you're talking about the MROS still up and down, that 20% to 30% range, which always happens. But given that you will start to get in the price recovery starting from, I guess, start of the 1Q fiscal next year, would you expect just maybe maintaining the high 20s, certainly through the first half of fiscal 2012 before you start seeing some pressures to the downside then?

It's going to depend on what segment we're talking about. I think there's certainly a possibility that we could do better. I don't want you to leave the meeting thinking that we haven't achieved price increases because we have. And we may not have achieved 100% of the margin recovery yet, but we intend to fully do that. So there isn't a huge amount that we are going to be lagging behind here, trying to recover. I think we're going into the forecasting period right now, Nigel. And what we'll do is we're going to go around from group to group and be evaluating just exactly what we think the possibilities are. We'll be sharing that with you because, of course, we're entering into our fourth quarter now. And I don't have any input yet back from the groups, but I think a lot is going to depend on what they have going on, maybe some of what happens here with respect to acquisitions. Keep in mind, early days of acquisitions puts pressure on the P&L. It doesn't put -- and that'll put pressure on the incrementals. It will not impact cash flow in a negative way though. So again, I'm going to try to steer you back. When we started doing acquisitions, I must steer you back to cash flow. Because an acquisitive company, you've got to be looking at that side of the equation even more so than the margin side of the equation. So yes, I think there's possibilities in some of these regions and segments that we could do better on the MROS. A lot of it's going to depend on our innovation and investments we're making there and some of the other things that I brought out earlier as far as added SG&A that we have to have to support the additional growth.

Okay, great. And then, just want to calibrate some comments on M&A. Can you maybe comment on the sorts of multiples you've seen coming through from some of the M&A we're seeing in the sector. Could you conceive of paying sort of mid teens EBIT multiple, based on what you've seen in the backlog? And secondly, it sounds like you're quite active in terms of special opportunities. Anything of size in the backlog that could break free?

Well, we don't predict success. Acquisitions are a funny thing because it can go. You can have something gone. It seems like it's going through a close and something happens at the last minute. And when that happened to us a few years back, for those who've been around watching, we ended up with a real fiasco on one of them. And we finally survived. But I think it depends on the market segment that you're looking at as far as the multiples. I think in general, industrial-type acquisitions used to be in the 7% to 8% EBITDA range. And now we're seeing more in the 8% to 9% EBITDA ranges in some cases. I think in some segments, there's an aerospace company. You're going to see EBITDA's 10%-plus type multiples on EBITDA multiples. And in other segments of our business, would have higher multiples too. So it really depends on what segment we are talking about. But generally speaking, the multiples have been -- are going up, okay? It seems like the multiples -- they went up toward the last part of this last run-up in 2008. There were high levels. Doesn't look like they dropped a whole lot. So I think the expectations are still high. And with the amount of cash that's out there potentially chasing these, we'll see what those levels can sustain or not sustain going forward.

And our next question comes from the line of Henry Kirn with UBS.

Is it possible to talk about ex-Japan? The global supply chain and impact on your OEM customers and in turn, how that impacts your OEM sales outlook over the near term and next year?

Are you talking about Japan?

Ex-Japan. You talked about Japan earlier and gave some quantification. So I just wanted to check on the rest of the supply chain.

In other segments, in other regions and other market segments in that?

Exactly.

Okay. I can give you kind of a quick rundown. I'm not going to go into a lot of detail here, but I'm going to give you a quick rundown. I think everyone's seeing now and realizes that this economy is in full swing in recovery. We are seeing basically improvement across all the segments and all the regions around the world in our business. I'm going to give you some kind of highlights here. As far as regions are concerned, North America continues to accelerate. I hope most of you understand what a 3/12 and a 12/12 cyclical are by now. But basically, I'm going to give you this real quickly. In North America, our 3/12 and our 12/12 cyclicals are running at about 130%. And that's extremely strong, okay? And that bodes very well for a go forward year finishing this year and going into next fiscal year. Europe. Orders are accelerating, and they're both also the 3/12 cyclical and the 12/12. This is their last 3 months orders divided by the previous year, the same 3 months. That rate of change and the 12/12 rate of change are also very strong at about 130%. Latin America's 12/12 is about 120%. So that's running real strong. Asia is strong. The 3/12 and 12/12 in Asia is 120% to 130%. So when you look at around the world for Parker, I don't think it's ever been better. I mean, the whole world is really -- is doing very well here. Our backlog, when you look at the backlog that we have, it increased about 6% over the last quarter. And on a year-over-year basis, we increased our backlog 24%. So we've got a lot of orders in the backlog. We've got a lot that we have to deliver on…

That's really helpful. And could you talk briefly about the inventory levels at the distributors and at your OEM customers?

Well, that's a good question. On our distributor level -- I think our distributors, of course, have added to inventory. I think as their business has ramped up, they're adding -- we're doing a better job here at delivering to them. And I think this is typically the part of the cycle where Parker does the best as far as penetrating market and gaining market share, because of our service levels. So our distributors are, of course, adding inventory, but they're not adding it at a disproportionate rate to the activity levels that they're seeing in their business, okay? That's kind of the way I would characterize our distributor inventory. I can't speak really for the OEMs because they're all over the map, okay? But I think everyone's been pretty prudent here as far as inventory builds over this cycle. So I don't see anything dramatically happening one way or the other as far as our customer inventories are concerned. I think, too, it's reflective of what the activity they're seeing in the marketplace for the most part.

And our next question comes from the line of Ann Duignan with JPMorgan. Ann Duignan - JP Morgan Chase & Co: Just a few kind of more broad-based ones. Don, can you talk a little bit about -- you're probably going into your planning process right now for 2012. And with revenues back at prior cycle peaks and the color that you've just given us on the 3/12s and the strength in some of the end markets, are any of your senior leaders requesting CapEx for expansion? Are we back into a mode where you're now looking to loosen purse strings on investment in capacity?

That's a good question, Ann. I would say, what I've been seeing here primarily of late is more activity that's geared toward -- some CapEx, of course, across the board, across all of our groups. But more focused on the Asia region. I think if you were to say, "Where are we deploying a disproportionate amount of CapEx?" It's going to be in Asia primarily. And I think you're going to see that going forward for some period of time, just to support the volume that we're seeing out there. 2% to 3% is still the relative range, okay? We're, I think, below 2% here of late. I think, 2% to 3% would be more of a relevant range that you can plan on. And what was the other question you had? Was there another part to that? Ann Duignan - JP Morgan Chase & Co: No, but I do have a follow-up, yes. If you look at the end markets such as machine tools and construction equipment, even mining equipment, you touched so many end markets and so many customers. Are you hearing any concerns from any of the customers? Or are you picking up any -- anything that might be related to prebuying ahead of the 100% depreciation allowance which expires at the end of the year? And I think about if you're going to buy machine tools, why not buy it this year when you can depreciate it.

Ann, I can honestly say I have not heard that. I won't say that some of that isn't happening, but it hasn't gotten to my level if that is happening to any great extent. Ann Duignan - JP Morgan Chase & Co: Okay, that's good color. I appreciate that. and I'll get back in line, most of my questions have been answered.

Thanks, Anne.

Our next question comes from the line of David Raso with ISI Group.

More of a clarification on the use of the balance sheet, Don. When I'm thinking about the base you've now given us for '11 and you just keep it simple, you think of sales up 10% to 15% next year, I know your orders are up more, but you had to assume with the comps flows. The sales were up 10% to 15%, you just do 20% incrementals. You're still talking $7.50 or so of fiscal '12 EPS. But the difference between $7.50 turning into over $8.00 is probably going to be the use of the balance sheet. And you made the comment that structurally, you think of acquisitions of adding about 5% to your annual growth. And that fluctuates year-to-year. But 5% is only $600 million or so for next year. And I'd calc you've got about $1.5 billion of firepower. But even if you use $1.5 billion right now, your net debt to cap is only 25%. How much are you thinking about for next year? I know it takes two to tango on M&A, but we've got the whole ball of wax.

Exactly. David, if I could do $1 billion, I'd do $1 billion, okay? I think when they put it that way. So I'm not shying away from doing it because of any capital constraints. We're going to have plenty of capital. We've got a strong balance sheet. We can do as much as we want to do. And if I can come up with $1 billion -- there was a year coming out of the last recession, we did $1 billion one year, if you recall. We did $500 million the next year, $600 million. So it's all over the map. Sometimes, they all line up nicely. In other times, they don't. But I don't want to leave you the impression that we're going to stop at $500 million. That's not the intent. I mean, we'll do $1 billion if we can get our hands on $1 billion worth of good businesses that fit nicely with us. We'll do it.

And would repo be part of the use of the balance sheet with any real significance if you can't get deals done? Or do you just feel you're in that spot of the cycle, better to keep the gun powder dry?

At this point, I'd like to keep some dry powder to do it. And I think if this is going to happen, we are going to get opportunities. And I don't want to take that kind of action and then have -- and not have the dry powder available when I need it.

Two other quickies if you don't mind. Other income, a little more of an addition to the quarter than I would have thought. Anything there? And then second question, about International margins. But first on other income, anything you unique there?

Are you talking about the other expense, other income below segment operating income, David?

I mean, I assume there's some relation between the two. But I'm in the idea that the other income on...

Yes. Well, actually, what happened in the third quarter is we had, like I say, some favorable settlements on insurance but offset by some higher expenses i.e., LIFO, for example. So it's a mixture of items and some asset write-offs. As you well know, a lot of things go through that particular category.

Yes, there is. I mean, on the P&L, it went from $6.6 million sequentially to $12.4 million. It added about $0.04 on my model.

Yes, that $12.4 million is actually positive from the insurance settlements. There's about $0.06 in insurance settlement.

Okay, and then the international margins. I know the fourth quarter implied, we'll see how it all plays out. But the decline, understandably, in the incremental margins going forward, I understand that. But on international, I mean, the incrementals are falling more quickly than the other. And basically you have 50% of first quarter to 40% to 30% just now to imply in the fourth quarter. International incrementals are down at 22.7%. And the other divisions, North America, the incrementals, not the same degradation? Is there anything unique to why the degradation there is greater?

David, it's Don. Just a couple of things with the European restructuring. I think I may have mentioned or may not have mentioned earlier, was about $0.05 for quarter 4. And that'd be coming in the international sector or segment. And then Japan would be one of the other areas that would impact that for the most part. A be a big portion of that would be on the international. Can you think of -- was there anything else that you had there?

No, that's it.

And if you add that back, it's a little more reasonable, same kind of degradation?

Yes, that's right.

And our last question comes from the line of Mark Koznarek with Cleveland Research.

Could I just ask for a little more clarification on Aerospace? There was some comments about some program activity there. And I'm not sure if you're referring to sort of the company-funded R&D or what is happening? But nevertheless, if you are experiencing an increase in the company-funded R&D, is there an offsetting reduction in anticipated spend next year? Or is this just an overall expansion in scope and the increase will be with us for the foreseeable future?

Mark, this is Jon. Just to try to respond to that for you, I think what we're seeing here in Q4 is an increase in the R&D due to a couple of reasons. Some programs being delayed, which is just going to increase cost for us over time in terms of getting the development done as specifications change, as scopes change as some of the programs that are being delayed. We've also got some overlap issues, as Don was talking about in his earlier comments that are causing us to work on more programs, more development programs in one quarter than we normally would at any other point in time of a cycle like this. So I think that it is really not a pull forward from FY '12. It's more of a continuing delay on some programs that are being delayed, and overlap on some of the programs that are all in development by all the OEM commercial manufacturers. And it's also an indicator of a few more quarters to go of these increased development levels here in order to get some of this newer generation of technology and systems done on time to our customers' specs.

So it sort of implies in the near term, we shouldn't be expecting that you'll be getting back to sort of the prior peak margins that this segment has been able to achieve, that it sounds like it's further down the road?

Yes. As Don said earlier, we'll be taking a real hard look at FY '12 during this quarter as we go into our year-end. So we're going to have a much better picture. I think over time, for sure, the margins are going to increase. We know that we've been bottoming out. We had a bottoming out period in Q1 with the 10% ROS for that segment in Q1. And as you can tell, we're steadily going up to the 13.6%, 13.8% timeframe now. So as our revenues go up, the percent of the R&D costs, the company-funded costs as a percent of sales are going to go down. And our margins should be continuing to go up. But the actual gross development expenses, at least for the immediate future, is actually going to most probably be around this level. But we'll be able to update you more specifically when we give you our year-end report.

Okay, and just one clarification from the response to an earlier question on the acquisition pipeline. Don, I think you mentioned you were looking at 12 properties. Would you be able to sort of give us a rough idea of the revenue opportunity there and what that would compare to, say, three to six months ago of the revenue opportunity that you were looking at, at that time?

Well, the revenue opportunity -- I think most of these would be in the range of $50 million to $200 million type size range for the company that we're looking at. If you want to compare that to what we looked at six months ago, it was 0 because we weren't going to do anything. I mean, maybe not six months ago, probably a year ago. We were just not going to do anything until we saw some relief from the subprime crisis. And we had no idea how bad that thing was.

Yes, I'm trying to think a more recent comparison.

Yes. Well, I think we are looking at a lot more now. There's certainly more activity going on in the company. We've engaged the entire organization. We are much more consistent now, and consistently going and pursuing these than we where six months ago or even a year ago. So there's no question that we've ramped this up to a whole new level.

Thank you. I'd like to thank everybody for their questions here. And now I'll just turn it over to Don who has a few closing comments. Thank you.

Well, I just want to tell everyone on the call that I thought this was an excellent call. I want to thank everyone for joining this, taking the time to join us this morning. I also want to take the opportunity to thank our employees worldwide for their continued commitment to serve the customers our customers. This is the time of the cycle when we generally do very well as far as penetrating market. I think we're doing that now. And certainly, for the record performance that we are posting this fiscal year, the team has really done a great job and should be commended for that. They are executing the Win Strategy. Interesting, the Win Strategy now, for those on the call that have been around for 10 years with us, and many of you have, it's in his 10th year of existence. So I mean, we've been at this for a long time. We're starting to see some of what's come out of a lot of this hard work and effort. So we're going to continue to achieve many new records going forward. So just thanks again for all of those on the call, for your participation and certainly for your continued interest in Parker. And just to let you know, Pam will be around the balance of the day for any additional questions that you might have. Okay, so goodbye, and have a great day.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a good day.