Parker-Hannifin Corporation (PH) Q3 2011 Earnings Report, Transcript and Summary

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 some of the records that we've had for this quarter. The sales were a third quarter record, all-time record for the company and never achieved before. Net income was an all-time quarterly record at $282 million. Diluted earnings per share was an all-time quarterly record, never achieved before at $1.68. And as we look forward to quarter four, I want you to reflect back on the fact that the third quarter was a record, all-time record for the company. So we'll get into some of those discussions later. We can talk about the comparison as to what the third quarter delivered and what we're delivering in the fourth. Total segment operating margins were a third quarter record at 14.8%, which was just under our 15% target. But more interesting, when you look at our Industrial North American margins, they led the way with 16.1% margins. Again, when we talk about our 15% target for the company, we have been talking about trying to maintain that as an average over the cycle, understanding that we'd like to be a little higher than that at the better parts of the cycle and when we're on the down part of the cycle we'll be a little bit less than that. But we would like to -- the goal of the company, the stated goal for quite some time now, has been to try to target that at 15% over cycle. And the reason for the 15% has been -- it puts us on the top quartile of our peer group, a very difficult peer group that we've established for the company. We didn't just pick the number out of the air. 15% puts us in that top quartile. So to have Industrial North America today at 16.1% margins, we're very, very pleased with that. And likewise, our Industrial International margins, which were quite depressed as you know through the recession, came in at an impressive 15.5%. So both of those major segments of our business are running well ahead of that 15% target. Our MROS, or marginal return on sales, was 28% in the quarter, and year-to-date, reached 33%. And as I think everyone understands the math here, the MROS is the change in total segment margin divided by the change in sales. We're certainly very pleased with the MROS numbers, and that the thing that's really pretty exciting is we talked about at the beginning of this fiscal year, that we wanted to hit 30% for the year. And it looks now based on the guidance that we're giving you, based on our nine months' actual numbers, that it looks like we're going to hit right about that 30% number. So we're pretty pleased. Now keep in mind, each segment has their own set of things going on, ups and downs and the gives and takes and that nothing's linear here. So the way we got the 30% may not be exactly the way we thought we're going to get there at the beginning of the year. But the good news is, we're there nevertheless. Operating cash flow, as you noted, was strong at $800 million, or 9% of sales. Our balance sheet is also very strong. And our debt levels -- with low debt levels on a strong cash position. And certainly, this gives us a flexibility to invest in other growth initiatives and opportunities as we go forward. While we still also did another of what we thought was a shareholder-friendly thing here, we raised our dividend 16%. And so our shareholders should be happy about that. And that makes it, by the way, 42% for the year. So we've been really hitting that. I think we had five quarters, we've increased the dividend now five quarters. Of course, we've increased the dividends for 54 years. But just in the more recent period, five quarters in a row. So we're in a very strong position as we approach the fiscal year-end. As a result, we've increased our guidance for earnings from continuing operations to the range of $6.20 to $6.40, from where we -- from the $6 nominal to a $6.30 nominal per diluted share. And this now represents a 5% increase from the midpoint of that previous guidance and an 85% increase year-over-year. So with that, I'm going to turn it back over to Pam for a more detailed review of the quarter.

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 forecasted. In spite of this though, however, the expectation is that income and earnings per share will continue to improve, adding to shareholder value. Also in the quarter, Aerospace saw some headwinds from program development costs. And this is expected to continue into the fourth quarter, and it's also the reason for the decreased margin guidance. And I'll talk a little bit more about Aerospace when we get to that slide where it displays the results. So although minimal, the largest impact from the Japan disaster is currently being seen in the Climate and Industrial Controls segment, where, as all of you know, there is Automotive exposure. So while there's a little impact in the third quarter, there is some in the fourth quarter, which accounts for the decreased guidance in that segment. Now moving to Slide 7, laying out the components of the $0.74 increase in earnings per share on the segment basis quarter-over-quarter and year-over-year from $0.94 to $1.68. The significant puts and takes are as follows: segment operating income added $0.79, other expense added $0.05, taxes cost us $0.06 and additional shares outstanding cost $0.03. Segment operating income increased across all segments of the business. Other expense decreased favorably, generating an additional $0.05 in earnings per share, mostly due to favorable insurance settlements realized in the quarter. The tax rate increased in the quarter due to favorable discrete items last year and unfavorable discrete items this year. So if you exclude these discrete items, the tax rate was actually lower. And of course, shares outstanding increased year-over-year due to the impact of the stock options. Moving to Slide #8. Looking at the top line, the third quarter record revenues for the quarter increased almost 24% to $3.2 billion from $2.6 billion last year. The impact of acquisitions was less than 1% at 0.7% and currency was in addition to sales of 2.5% in the quarter. After you exclude these impacts, the third quarter organic growth was almost 21% at 20.7%. So most notable, I guess, is that sales at the current run rate are above the prior peak with continued robust orders. So moving to Slide 9 and focusing on segments commencing with Industrial North America segment. Industrial North America reported revenues, an increase of 23% in the quarter. Acquisitions and currency added approximately 2% to revenues in the quarter. So thus, the quarter revenues increased 21%. 21.3% to be exact. Operating income increased from $134 million to $189 million, a 41% increase. And the operating margins increased 220 basis points over the same quarter last year. So you can see the performance is quite good in the North American segment. Slide 10, I'll address International. Organic revenues increased 24% year-over-year, and currency in the International segment this quarter moved from a negative last quarter to a positive this quarter and added 5.6% to revenues. Acquisitions had little impact in the quarter, adding 0.6%. And if you total this up, the reported revenues for the quarter are obviously almost 30% at 29.9%. So in spite of increased input and ramp-up costs associated with this robust demand, this segment reported operating margins of 15.5% in the quarter versus 11% last year. So moving to slide number now and focusing on Aerospace. Aerospace reported organic revenues of 12%, a nice organic revenue increase for Aerospace. And of course, currency and acquisitions didn't have any impact on that segment this quarter. Margins increased 260 basis points for the quarter, year-over-year to 13.7% from 11.1% last year. And as I mentioned earlier, there are some headwinds from program development costs that are seen in the third quarter, and this will carry into the fourth quarter and accounts for the decreased guidance in the second half. While the segment realized higher program development costs, however, margins have steadily improved throughout the year and incrementals for the quarter were very respectable at 35%. So moving to Slide #12, Climate and Industrial Controls. Reported revenue increase for them 25%. 24.6% to be exact for the quarter. Acquisitions increased revenue 1.7% and currency added almost 2%, 1.9%. Base revenues increased 21%, 21.3% again to be exact. And margins as a percent of sales were 8.6% for the quarter versus 7.7% last year. On a year-to-date basis, margins are up 80 basis points. As I mentioned earlier here today, the effects from Japan's recent disaster, it'll be seen in the fourth quarter. While minimal for the company, this does account for the guidance decrease in this segment. So now we'll move to orders quickly. And just as a reminder, everybody on the call knows this, but the numbers represent a trailing three-month average and reported as a percentage increase of absolute dollars year-over-year, excluding acquisitions and currency except for Aerospace. And Aerospace is reported using a 12-month rolling average. As you can see from this slide, orders are up 24% for the March quarter just ended. This compares to 29% last quarter. But please note that the sequential decrease in order rate improvement is due strictly to tougher comparables. In absolute dollar terms, orders have increased sequentially second quarter to third quarter. So we are coming up against some tough comps, and that's what you're seeing. Orders remain very robust. North American orders for the quarter just ended increased 20% year-over-year, and this compares to 26% last quarter. And Industrial International orders increased 22% year-over-year and compares to 29% last quarter. Aerospace orders, very robust at 44% for the quarter, which compares to a positive 37% last quarter. And in the Climate and Industrial Controls segment, orders are up 14% for the quarter compared to 26% last quarter. So you can see that the order rates add further to the momentum of our business as we currently sit here today. So moving to the balance sheet and quickly. Our balance sheet remains solid. But a lot of cash on the balance sheet at more than $1 billion with no commercial paper outstanding. Inventory increased $29 million during the quarter. However, that was mostly currency, and DSI decreased five days to 57 from 62 last quarter, so nice improvement in inventory. Accounts receivable in terms of DSO is 49. This is up 3 days from last quarter but consistent with last year. And as you know, we continued work and made progress on our weighted average days payable outstanding. So moving to Slide 15, if we can. Net cash provided by operating activities for the quarter was $392 million, representing a little over 12% of revenues. And on a year-to-date basis, net cash provided by operating activities was $800 million, or 9% of sales. The major components of the uses of the $392 million in operating cash flow for the quarter are: $78 million returned to the shareholders via share repurchases of $26 million and dividend payments of $52 million. And as you well know, Don just mentioned, we did a dividend increase, just announced it, taking it up 16%. And as he mentioned, 42% for the year. Also, $17 million of cash was used in connection with acquisitions, and $49 million in connection with capital expenditures, which represents 1.5% of revenues. So as a result of this and more, cash increased $299 million in the period. Not in this quarter, but in this year, a $200 million contribution to the pension plan was made. So on Slide 16, you could see that the debt to total cap ratio is 25.3%, and that's down from 26.5% last quarter. So now, moving to guidance, which is what you're all interested in. On Slide 17, the guidance for revenues and operating margin by segment has been provided. And then moving to Slide 18, guidance has been provided for the items below segment operating income. Slide 19 summarizes the guidance on an earnings per share basis. And as you can see from this slide, the guidance for fiscal year 2011 for earnings per share is projected to be $6.20 to $6.40. And that represents a $0.30 increase at the midpoint from the previous guidance provided. Please remember that this forecast excludes acquisitions that may be made in the remainder of this fiscal year. The revised guidance is due to increased operating income and assumes the following at the midpoint: increased revenue, year-over-year, greater than 22%. And this is an increase from almost 18% last quarter; segment operating margins of 14.9%, which Don already mentioned, basically flat with last quarter guidance; below the line items, which are expenses below segment operating income, including corporate administration interest and other, they're assumed at the midpoint to be $387 million. And the guidance incorporates a range of plus or minus 1%. And this is within $1 million of what we said last quarter. The full year tax rate projection is 27%, again consistent with what we said last quarter and just a couple of points with respect to this guidance. While some realignment costs are moving to the fourth quarter from the third quarter, realignment costs are still projected in the normal range of $0.10 to $0.12 for the year. And fourth quarter EPS, as I'm sure you figured out by now, will be higher than third quarter. So at this time, we'll open -- we'll now commence with the Q&A session.

[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 have a little bit of a lag, and we pretty much acknowledge that. And I would say, we're seeing a little bit of a lag now, but nothing usual because you always go through a negotiating period, especially with the OEMs. And typically, you raise OEMs on the anniversary of the contract, unless you're doing surcharges or other things that you might have to do due to inflation taking hold. I think we're going to be caught up at least with the latest rounds of increases that we've seen by the end of this quarter certainly. I don't think anything's going to extend out beyond the end of this quarter, any of the segments of our markets. So we're pretty much realtime. About as realtime as we've ever been as far as recovering costs increases. And then we've got to be realtime, otherwise we wouldn't be able to deliver these fantastic margins that we're delivering. The 16%, 15-point-some % International, just wouldn't be in the cards. So that's pretty much it. I think we're doing a pretty good job there. So let's come back, and I think, Jeff, your comments about MROS -- maybe I'll make a few comments about that now since we're talking about it. When we are -- first of all, the place where MROS came from with respect to Parker is right on our Win Strategy. If you look on the back of our Win Strategy, we're very explicit that that's one of our targets, 30%. And that doesn't mean that every point in the cycle, it's going to be 30%. What we typically look at here is that at early parts of a cycle, when you're in a deep hole and you're digging out of a deep hole and you've got a lot of part-time people and associates and you don't have full-time benefits and you've got all of these reduced costs that you're dealing with, when you get an incremental sales at that level, you should be in the 30% to 40% as far as incrementals. You should be generating those kind of incrementals. And that's what we typically have been targeting, that's what we've been seeing, 30% plus. We set 30% for the year as our target, and I think we're going to hit that. As the cycle matures, just on a comparative basis, you're up against tougher comps as you go deeper into the cycle. And so a more relevant range at that point would be 20% to 30%. Of course, our gross margin as a company is 25%, so you can't be delivering 35% forever unless you're shedding a lot of lower margin business somewhere. And we're not planning to do that. So as the cycle matures, you have to add SG&A. There's certainly effects from a restructuring that might be going on, acquisitions obviously affect MROS. R&D activities, innovation, a lot of other things affect MROS. But that's kind of the way we think about it here. It's not something that anybody here gets paid based on. We get paid on bottom line results, on earnings and return on net assets. So it's more of an indicator as to how we can compare group to group and situation to situation. So it's not a mandate. It's more of a metric that we look at as -- just one of the other metrics that we look at around here. So that's how we look at it. If you look at North America, third quarter, I believe, was 25% incremental. Fourth quarter implied guidance would be 22%. We're still looking at about 29% for the whole year in North America. And just a couple of things that would be affecting that, of course, I mentioned under cost recovery and the possible slight lag there which is more typical than not. Keep in mind that some of the groups are operating at fairly high ROSs already. So that makes it more difficult to continue to ramp those numbers up higher than that. And then also, when we look at the third quarter and the fourth quarter, we're looking at -- starting from a record third quarter at 16.1% ROS and going to what will turn out to be another record fourth quarter at 16.6%, even with the 22% incremental. So we're not concerned all that much about the incremental, frankly. We want to hit those ROS numbers and return on net assets. That's what's critical to us. If you look at Europe, we started in the third quarter at about 30%. We're down at 23% now. A lot of the same kind of things happening there. We had a little restructuring that was moved from the third quarter to the fourth quarter. That was about $0.05, I believe, the number was. We're not seeing the full impact of the surcharges that went out in late February and throughout March. And we will be seeing that throughout the balance of the quarter. So that's coming. And again, we're running at pretty high ROS numbers already. And then the last thing that of course is impacting the rest of the world industrial would be Japan. And the way to think about Japan is -- for the third quarter, we're looking at the impact of Japan on Parker, total Parker, being about $5 million top line, about $1 million bottom line. And then if you look at Japan for the fourth quarter -- and this is kind of a rough number, don't hold us to this. If you kind of want to run around the company and ask what kind of impact from the different operating units and kind of roll this up, we're looking about a $20 million impact top line, about a $5 million impact bottom line. That could change though as more becomes known about just how bad things are over there and how fast they can get back up on their feet. So that would be affecting the rest of the world industrial numbers. But even having said that, we're going to be setting some very, very high ROS numbers even with those kind of incrementals. Aerospace, Pam touched on -- third quarter was 35%, fourth quarter implied would be 24%. We've got some R&D activities that have been brought forward, and that kind of overlapped with some schedule changes which have moved out. So we have kind of the overlap situation that's causing a little bit more cost and a little bit more delay here as far as improving those margins faster than what we would like to see. But nevertheless, we've had pretty nice incrementals, and we'll finish the year at about 24%, 25%, the way we've projected right now. So not bad overall. CIC was extremely low in the third quarter at 12% incremental going up to 17% I believe the number is in the fourth quarter. Total year is going to be about 15%. And again, Pam mentioned the impact there is primarily the Japan impact on the customers for the CIC to Automotive customers primarily. And that impact will be about 40% of the amount that I just gave you. I said $20 million top line, $5 million bottom. About 40% of that hits the CIC group. The balance is spread amongst all the other groups in the regions. They've also had some restructuring in the third quarter, which, of course, suppressed that MROS in the third quarter and makes the fourth quarter obviously look better just based on that comparison. And then the last thing, I believe, is that we're seeing a little bit colder spring. And that affects a little bit of the air conditioning part of that business. So I know that's a lot on MROS, but I know I've seen some of the early reports come out and a lot of concerns about MROS, a lot of discussion. And I hope that, that adds some clarity to that, and then also adds some clarity as to what we're doing recovering costs.

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 at much higher levels through the P&L than we've ever done before. So even with that, we're setting some of these records. Just going on then, Joel, the other thing that we're doing is we're funding the pension. We've taken a couple of hundred million now in the fourth quarter here, and we're going to be topping off the pension. That'll be kind of a -- maybe a pull forward from next year. This really wasn't required until next year, but we felt there was a good use of cash right now to put it to use. And that is -- instead of having it sit making 0%, having it hopefully invested, making more invested in the pension funds. So we took the $200 million, we're doing that. That's on top of the $200 million we did in the first quarter. So we've really topped off the pension very nicely. The next time we would need to do something might be in 2013, and that will depend on a lot of other metrics going forward as far as how much we'll need to put in. So after you go through all of that, that's where our number one priority is. We're doing $80 million a year in share repurchases for stock option exercises and share creep due to that. And our first priority will be those other things -- if nothing materializes there, we certainly could consider share buybacks. But that's not really on the table right now.

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 going forward. Some of you watch the ISM and the PMI indices. And those industries are all strong. 61% in North America, 57% in euro zone. Again you'd see something north of 50%. All of the European countries, Germany is very strong, U.K., Switzerland, France and Sweden are all strong. So everything is going very well there. China's PMI is about 52%. So they are still expanding. I'm not going to go through all of -- I've got a chart here that has a lot of colors on it. But in a lot of different markets that we serve and where they stand -- I'll just tell you what the strongest ones that we serve, or the strongest market segments right now of all of the ones that we serve, and not that any one of these would make up a big part of our total sales, but I'll just tell you what they are. They are construction equipment, machine tools, telecom, mining and industrial trucks and material handling. Those would be the strongest segments -- all market segments are up. Those would be up the most, okay. The ones I just mentioned. So unless there is some other specific area that you'd be interested in, that's kind of a brief look. But all news -- i mean, this is an easy report because everything looks so good.

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.