Jan 17, 2008
Executives
Pam Huggins - Vice President andTreasurer Don Washkewicz - Chairman,President and CEO Jack Myslenski - Executive VicePresident, Sales, Marketing and Operation Support Tim Pistell - Executive VicePresident and Chief Financial Officer
Analysts
Robert McCarthy - Robert W. Baird& Company Nigel Coe - Deutsche Bank David Raso - Citigroup GlobalMarkets Daniel Dowd - SanfordBernstein Chase Becker - Credit Suisse Robert LaGaipa - Oppenheimer Mark Koznarek - ClevelandResearch Andy Casey - Wachovia Securities Jeff Hammond - KeyBanc CapitalMarkets
Operator
Good day, ladies and gentlemenand welcome to the Parker-Hannifin Second Quarter 2008 Earnings Conference Call.My name is Sab, and I will be your coordinator for today. At this time, allparticipants are in listen-only mode.
We will conduct a question-and-answersession towards the end of this conference. (Operator Instructions).
As areminder this conference is being recorded for replay purposes. I would now like to turn thepresentation over to Pam Huggins, Vice President and Treasurer.
Please proceed.
Pam Huggins - Vice President and Treasurer
Good morning. This is Pam speaking.I'd like to welcome you to Parker-Hannifin's second quarter 2008 earningsrelease teleconference.
Joining me today is Chairman,President and Chief Executive Officer, Don Washkewicz; Executive VicePresident, Sales, Marketing and Operation Support, Jack Myslenski; andExecutive Vice President and Chief Financial Officer, Tim Pistell. Jack Myslenski is joining ustoday to provide some color on Europe in connection withthe Q&A session at the end of the call.
Prior to proceeding to theearnings release, just allow me to address a couple of administrative matters.First of all, for those of you who are following this online, the PowerPointslides have been presented, and will remain there for some time. For those ofyou not online, the slides will be posted on the IR portion of Parker's websiteat phstock.com.
Second, as is customary, I wantto call your attention to Slide number 2, which is the Safe Harbor disclosure onforward-looking statements, and again as is customary, I ask that you read in itsentirety if you haven’t done so. And then of course moving Slide number 3, thisslide, which is required, indicates that in cases were non-GAAP numbers havebeen used, they have been reconciled to the appropriate GAAP numbers.
So at this time moving to theagenda on Slide 4, again the call will be in four parts today. First DonWashkewicz, the Chairman, President, and Chief Executive Officer will providesome highlights for the quarter.
Second, I'll provide a detailed review of thequarter, concluding with of course the upwardly revised outlook for fiscal year2008. And then third part of the callwill consist of our standard Q&A session, and as a reminder, you get thisevery quarter, but please, please, ask one questions at a time.
I want to makesure that everybody has a chance to participate on this call. And for thefourth part of the call today, Don will close with some final closing comments.
So at this time, I'll turn itover to Don and ask that you refer to slide number 5 titled, Second QuarterHighlights.
Don Washkewicz - Chairman, President and CEO
Thank you, Pam, and good morningto everyone on the call. I just have a few comments and then Pam will returnfor a more detailed review of the first quarter.
First of all, just some highlightsfor the quarter and for the half. We are certainly very pleased with the strongfirst quarter and half for the fiscal 2008.
In addition, we see enough strengthnow for the balance of the year to increase our earnings guidance; I know we havejust done that this morning. This confirms our views that weshould produce another record year of sales in earnings, which would be ourfifth year in a row of record results for the Corporation.
And then I thinkthat itself kind of goes to show that we have exhibited pretty strong strengththat are pretty much across the cycle. Our record result this quarteragain highlights Parker’s new balance.
Our sales again in North America made up nearly half of our revenue in the quarter, andthis was pretty typical of what we saw last quarter. We are very pleased withthe ongoing growth in Europe, Asiaand Latin America and we'll have an opportunity to talkmore about that later in the Q&A.
In fact organic growth in the InternationalIndustrial segment during the quarter was up over 11% and we are very pleasedwith that number. In addition, our operatingmargins in the quarter for our international business continue to exceed thatfrom North America.
As you know this has been a sevenyear work-in-progress starting back in the early 2000s and working on topresent and we are going to continue work on this to improve this even further.But our European team to date has done an excellent job, executing ourcomprehensive margin improvement strategy that we laid out back seven yearsago. Operating income in our IndustrialInternational segment increased nearly 44% compared to the same quarter oneyear ago, and that’s on a 27% increase in sales.
Lastly, organic growthcontinues to be a very healthy 5% this past quarter despite some soft marketsin North America. This level of organic growth exceededworld GDP growth in this last quarter, so we are very pleased with that aswell.
Earnings per share are up 12.8%.And all of this is being driven by our employees’ continued execution of theWin Strategy we’ve talked about that before. The Win Strategy is our road mapfor operational excellence for the Corporation.
Just a couple of comments onmarkets, and again we will have more opportunity to talk about various marketsand market segments in the regions later in the Q&A session. But keep inmind that we have about a two month visibility on the industrial backlog, andabout one year in aerospace backlog.
With that in mind our orders are up 10% inthe quarter, so they are double-digit versus a year ago with particularstrength coming from our International, Industrial and our Aerospace segments. As with the case last quarter ourdistribution remains strong and this represents about half of our industrialbusiness and we expect continued strength in this channel for the foreseeablefuture.
Some North American OEM marketscontinue to be weak and nothing new here because we have talked about these inthe past. They are automotive heavy duty truck, refrigeration, and residentialair conditioning.
These markets have been performing at this level for quitesome time now, so when they return to more normal growth levels we should be ina position to benefit from that improvement. So with that I'll turn it backover to Pam for a little bit more detail on the quarter.
Pam Huggins - Vice President and Treasurer
Thanks, Don. And I'll ask you toplease refer to slide number six at this time.
To summarize earnings per sharefor the second quarter came in at $1.23, that's a 13% increase over the $1.09in the second quarter of last year. Moving to slide number seven, theearnings growth and I am going to do this on a segment reporting basis for thequarter versus the same quarter a year ago, so to provide detail on thatearnings growth.
First, revenues in the quarter increased 13% due to the Industrial,International, and Aerospace segments with revenues up 28% and 7% respectively. Second, the segment operatingprofit increased 13% and this was again led by the strength in the Industrial,International segment with an increase in operating income of 44% for thequarter that Don just mentioned.
Corporate, general andadministrative expenses were 9% lower due to incentive compensation in thequarter and fourth outstanding shares were lower mainly as a result of theaccelerated share repurchase program that was just completed in November. Now the entire earnings itemswere partially offset by lower Aerospace segment operating income primarily dueto development cost, lower CIC segment operating income, of course, due totheir exposure in several soft markets that Don mentioned as well.
And thenhigher interest expense, mostly the result of acquisitions and of course theaccelerated share repurchase program that I just mentioned. One thing to notehowever that interest expense as a percent of sales, as compared with last yearis flat.
We also had higher other expense due to currency and on theconsolidated statement you'll note that taxes were higher due to higher incomeand a slightly higher tax-rate. To summarize the puts-and-takesfrom the second quarter on a per share basis versus a year ago, operatingincome contributed $0.17 so a quality quarter.
Corporate, general andadministrative expenses added $0.02. [Last] outstanding shares contributed$0.03 and all of these were partially offset by the additional interest expenseof $0.01, higher other expense of $0.05, and higher income taxes of $0.02.
So again, as I said a qualityquarter, if you net these items you can see that the earnings were quality earningsclearly with the result of their performance in the quarter. Moving to slide eight andaddressing sales, looking at the top line sales for the quarter of coursegained momentum increasing 13% to $2.8 billion from $2.5 billion last year.
Ofthis 13% sales growth 5% was organic, 3% the result of acquisitions and then 5%the result of currency, mainly the Euro. Moving to slide nine, the stronggrowth in the quarter is the result of continued strength internationally with11% organic growth of course led by Asia, Latin America and Europe.
Latin America continues to show improvement as we discussed last quarterparticularly in Ag, in Braziland of course Asia and Europecontinue to have double-digit growth. Our distribution and commercial side ofthe aerospace business continue to do well.
Acquisitions continue to contributeand Parker continues to make progress in emerging markets. So moving to slide 10 andfocusing on segments, starting with Industrial North America.
I think, mostnotable on this slide is that in spite of several soft markets, North Americansecond quarter sales are up 13% -- are up 3%, I apologize, 1% organic and ofcourse you can see that we are showing some momentum in this quarter in thatparticular segment. Margins increased to 14.3% from 14% a year ago and ofcourse this is the result of successful acquisitions, the resultantdiversification of our businesses and of course execution on the win strategyinitiatives.
So continuing to slide 11, withthe Industrial segment moving to international, noteworthy here is thatcurrency is becoming a larger contributor to sales, of 11% for the quarteragain due mainly to the strong Euro and of course that you know the weakeningof the Dollar. Organic growth continues at a high level reaching over 11% forthe quarter in turn contributing to a nice improvement in margins coming in at14.9% compared to 13.2%, last year.
And, of course, acquisitions added 5% toend sales in this segment. So international continues to do well across thevarious markets and strength is expected to continue in the foreseeable future.
Moving to Aerospace, most notablein aerospace in the margins in this quarter, margins dropped to 12.1% from16.9% a year ago. The decrease in margin this quarter is due to $5.20 million inhigher development costs in connection with the program wins, mainly the 787.This was discussed at the last quarterly call.
However, development costsmoving forward are expected to be higher than originally discussed. I'm sure most of you saw the releasethis morning.
We had a win on the A350, the fuel and the hydraulic system. So,again, just to reiterate, as a result of program wins, A350 being the onemoving forward, development costs will be higher.
Moving to slide 13, the Climateand Industrial Controls segment, as Don mentioned, softness in automotive,heavy-duty truck and residential air-conditioning continued to affect thissegment. About 10 million of the shortfall that we'll discuss later is due tobusiness mix, moving from high margin residential housing business to lowerautomotive, and about 7 million is due to the decline in sales volume.
I want to talk about orders alittle bit here on the slide 14. As you know, we're reporting orders on aquarterly basis now.
These numbers represent a trailing three-month average andare reported as a percentage increase to the absolute dollars year-over-year,excluding acquisitions and currencies except for aerospace. Aerospace isreported using a 12 month average.
Orders are up 10% for theDecember quarter just ended. This 10% is up sequentially from 7% last quarterand compares to 5% a year ago.
North America orders haveimproved sequentially from a flat number last quarter to a positive 4%year-over-year. And this compares to a negative 1% to same quarter a year ago.
Moving to international,industrial and international orders, they continue to show strength at 16% thisquarter versus 19% last quarter and 13% last year. And of course, thisinternational strength is supported by growth in Asia of22%, Latin America up 17%, and it continues to showimprovement.
And of course, Europe remains strong, up14%. Aerospace, it's strong across allsegments.
Orders are up 19% this quarter, which compares to 12% last quarterand 10% a year ago. In the Climate & Industrial Control segment, orderstrength as anticipated has improved.
Orders are down 6% for the quarter, whichis an improvement from a negative 13% last quarter. However, orders were down2% a year ago.
Moving to the balance sheet,slide number 15, Parker's balance sheet remains solid. Cash on the balancesheet at yearend was $198 million.
We have about $670 million in commercialpaper outstanding. Days sales and inventory improved one day from 71 a year agoto 70.
Accounts receivables, speaking interms of DSO, it's up one day, coming in at 50 days versus 49 days last year.And the large decrease that you are seeing in other assets and pensions andother post-retirement benefits year-over-year is the result of FASB 158. So moving to slide 16 now, I'mjust talking about cash flow.
Operating cash flow for the quarter came in at$205 million, another record for the company. Of this $205 million in cashflow, $62 million or 2.2% of sales was used in connection with capitalexpenditures.
Acquisitions consumed $430 million. Dividends were paid in theamount of $35 million.
And as a result of these items, debt increased by $318million in the quarter. On slide 17, you can see the debtto total cap ratio is 29.7%.
And on a net basis, it's 27.6%, thus providing thecapacity to generate premium returns going forward. I'll now address theguidance.
On slide 18 through 20, we havethe guidance figures. Slide 18 details the guidance for sales and operatingmargin by segment.
Slide 19, guidance has been provided for the items below,segment operating income. And slide 20 summarizes the guidance on an earningsper share basis from continuing operations.
As you can see from this slide,the guidance for fiscal year 2008 for earnings per share from continuingoperations is projected to be $5.15 to $5.40. This compares to the previousguidance of $5.05 to $5.35, so an increase of $0.08 at the midpoint.
Pleaseremember that the forecast includes acquisitions made to date, but it doesn'tinclude any acquisitions that we may make going forward. So, the revised guidance ascompared to the original guidance, just to give you some color as to what itincorporates, first of all, an improvement in sales in all segments exceptClimate & Industrial Controls for the items that I just mentioned earlier.Increased operating margins in North America and rest of world contributing$0.16 to diluted earnings per share, a lower tax rate contributing $0.03,higher interest expense due mainly to acquisition $0.07, and then of coursehigher corporate general and administrative expenses, although, general andadministrative expenses as a percent of sale will be flat.
So at this time, I'd like to turnthe call, alright I'd like to open it up to our standard Q&A session.
Operator
(Operator Instruction). And yourfirst question comes from the line of Robert McCarthy from Robert W.
Baird& Company, please proceed.
Robert McCarthy
Morning everybody.
Pam Huggins
Good morning, how are you?
Robert McCarthy
I’m fine Pam. How are you?
Iheard an interesting comment, when you were talking about Industrial NorthAmerica. You said showing momentum, are you referring to the improvement inorder rate in the quarter or are you trying to tell us something a little broaderthan that?
Pam Huggins
You're exactly right. That's whatI was referring to, that the orders as you can see, they're starting toimprove.
I think Don has talked about that, I know when we’ve been on the roadfor sure he has mentioned that. The interest rate has declined, and it takes awhile for that to show up, but obviously you can see in the orders, there issome improvement.
So that's what I was referring, you're right.
Robert McCarthy
And then for my follow-up, let meask about the revised guidance for profitability in the aerospace business.You're showing 14.1 to 14.5 down from a forecast that included 16 before. Is itstrictly a function of the increase in development cost associated with thisnew win, the A350 or is there more to it than that?
Pam Huggins
Now that's a very good question,and what has happened on the last call just to refresh a little bit. On thelast call, we talked about our development cost, and we said that we wereincurring more development cost in the first half and that going out in thesecond half that would decline somewhat.
And so you would see higher margins inthe second half. That's what we said before, but what has actually happened Bobis that development cost have been higher than we originally anticipated.
Overthe year it's going to be higher due to the A350, but there is some otherprograms as well.
Robert McCarthy
What's causing it Pam? Are theybeing accelerated or are we having finding that the scope of the programs, areexpanding or did somebody misestimate would they be upfront or what?
Don Washkewicz
Yeah, really Bob, this is Don.It's really a combination of all of those, some of which are accelerated, someof which the customers want us to explore two different options for aparticular part of the system instead of one, so we have to put more resourcesand so forth at it. It's really the combination of all that, and in addition tothat it's a result of a number of other programs that we won off-late as wellin a number of different categories including the regional jets, the businessaircraft, not only the 787 but some of these other areas as well and othercommercial airplanes.
So it's really that the total level of activity has justincreased dramatically, and frankly we just underestimated it.
Robert McCarthy
Yeah, okay. Alright, I'll getback in queue.
Thank you.
Operator
Your next question comes from theline of Nigel Coe from Deutsche Bank.
Pam Huggins
Good morning, Nigel.
Nigel Coe
Good morning, Pam, how are you?So just a quick follow-on to the previous question on with R&D. Does therevised guidance anticipate further pushback from the 787 or maybe a flatterproduction ramp up next year or do you think you're pretty intensive to that --to those assumptions?
Tim Pistell
Nigel, Tim Pistell, the guidancewe have given you right now does not include any push backs to us on the 787because we have not received any to-date. So, we are still performing to planand of course things can change, but we have nothing changed even in conjunctionwith our latest announcements.
Nigel Coe
Okay, great. And in terms of the-- again the previous question about momentum building in North America, would itbe fair to say that North America started off a little bit weaker then it actuallygot stronger during the quarter, maybe if you could answer that question interms of international as well?
Jack Myslenski
Nigel, this is Jack Myslenski, Iwill try to shed some light at least on parts of the international numbers and Imight expound upon what's going on in Europe, to[prevent] some other questions that may come up about what is going on there.But first of all, our after market sales continue to be strong year-over-yearwith a slight growth on a sequential basis, so our distribution has been doingrather well and on the OEM side and I'm specifically speaking about Europe, onthe OEM side we're very fortunate to have positioned ourselves in a number ofvery nice growth markets in Europe. Mobile construction continues to be verystrong in the UKand in Germany,continues to be good in Italy,France and Swedenwhich are the other major countries we were involved with construction.
We have also positioned ourselvesin that particular market in some -- what I would call some niche constructionequipment manufactures whose products end up in infrastructural building aroundthe world. Everything about marine is booming, it doesn't matter what part ofthe boat industry you are in, it just seems to be roaring all over.
Much ofthat marine market is being driven today by what's going on with oil and gasand some of the order books of our end customers are out as far as three years. We've also introduced some newinnovative products, piping solutions for this particular market.
We've rolledthat out in Europe, it's doing rather well and we planon rolling it out in other countries around the world where shipbuilding andmarine industry is very strong. We've also done well in the forestry pulp andpaper markets especially in Finlandand Sweden, andas expected all the businesses around oil and gas are very strong all over Europe.
Interestingly enough, one of thethings that's noticeable is we are doing a relatively good job in the heavyduty truck market in Europe contrary to what's been going on here, except Iwill make a comment about North America at this point. Even though the heavyduty truck market has been down and appears -- it appears to be at the bottomand as a matter of fact we have seen some positive signs the last couple ofmonths in that particular area.
Lastly our presence inalternative energy markets is reaping wonderful growth. This is especially truein the wind turbine market in Europe and in particularin Spain and Denmark.In closing on Europe, I am very positive about thefuture growth that we have there, primarily because we have the organizationset to be able to bring the true power of our products together.
And the otherthing that is interesting to watch as company's move around the world, oursales company organization around the world has been able to seamlesslypass-off the customers from one location to another around the regions of theworld. And then a quick comment about North America.
Distribution continues to be strong. Our government,military direct business is strong.
Again, our energy, gas, oil, mining are allstrong in the U.S.I mentioned heavy duty truck. Heavy construction is still steadyyear-over-year.
The only place where we've seen some softening there is onconstruction equipment that's related to commercial or residential building. Soit's the smaller construction equipment.
As Don mentioned semiconductorsappears to be at the bottom, but it is down and then air conditioning relatedto the housing is a challenge along with the cars and light trucks. So that's myflavor on the market both in North America and in Europe.
Nigel Coe
Very helpful. Thank you verymuch.
Pam Huggins
Thank you, Nigel.
Operator
And your next question comes fromthe line of David Raso from Citigroup Global Markets.
Pam Huggins
Good morning, David.
David Raso
Good morning. I'd like to discussthe order mix and after that [dovetail] into the margin assumptions for therest of the year.
Essentially looking to keep the North American margins in asecond fiscal half where you had in the first half international a little bitlower. Can you help us a bit Jack, when you just went through on the endmarket, some color around the first North America, the pick up in ordersexactly the mix of that?
You mentioned the idea of heavy truck a bit, but maybeexpand a little bit more on North America, where you are seeing orders pick upand how should we think of that as a business when it comes to the mix?
Don Washkewicz
Pam, [you go] on.
Pam Huggins
One of the things I want to say,when you are looking at the international margins, one of the things that youneed to be aware of is, if you look at the second half of last year and I knowyou know this David, but I just want to get this out. If you look at the secondhalf of last year, our margins were 13.5% moving up a 130 basis points to thesecond half of this year to 14.8%.
So, that's a pretty healthy increase secondhalf versus second half. Yeah, we are keeping it relatively flat going out,moving forward, okay.
But David, one of the things you need to think about toois that in the first half of the year, there are some things that take placewith respect to inventory versus the second half that make some difference aswell. We typically build inventory in the first half and we typically reduce itin the second half and when you're building it you get the benefit and whenyou're reducing it you don't.
So that plays into that number as well.
Jack Myslenski
David, a little color on Europe,on the margin side. We've been very fortunate when we go back and look at wherewe've been coming from and where we are at today.
If you remember, I'm suresome of the people on the call do remember, back in the 2002 area we wereapproximately making 6% profit in our international numbers and although wedon't tell you what our breakdown of those internationals are, I thinkeverybody knows that Europe is a main driver of ourinternational numbers. We implemented the win strategyin the three main initiatives there with the pricing and the [lien] and thepurchasing but along with that back in 2002, I outlined in one of our investordays, what we were trying to do on the cost side and the delivery side.
At thattime I mentioned that we are trying to improve our business by 3 percentagepoints with a stretch goal of 4%. I can tell you today that we've actually donethat.
We've reached 3% and we are actually approaching the 4%. So, the combination of the winstrategies and if you take a look and just use round numbers, if you rememberthe two plus two plus two, you throw in another three for the delivery system,that gets you approximately to the 15 that we are at today.
So, I'm happy thatwe have achieved those. I do not think that there isgoing to be huge incremental upside of what we can do on the delivery side withthe exception of some improvements on the order processing.
We've done prettymuch what I think we can do on the warehousing and the field salesredeployment. I would point out that there aregoing to be some expenses in the second half in Europeand they are directed straight at improving our organic growth rates there.We've recently opened up the new sales company in Turkey.We've actually done our first billing in that country this past month.
We will be opening up a salescompany Switzerlandand in Dubai in the second half.And the other place that we are spending some more money out is deployingfurther resources in the form of sales people in Russia, Northern Africa and inEastern Europe, most of the -istan countries. So there will be some expensesinvolved with the setting up of these sales companies as well as investing insome additional resources on the street.
So that's part of the reason thatthere is a little bit of a slight decrease in the margins on the second half inEurope on the international numbers.
David Raso
I appreciate this threshold costissues. Thank you.
My question about the mix, just trying to think through highhorsepower tractors in Ag is strong or the way you run your company's sealdivision margins above the hydraulic margins. I'm trying to get a feel when Isee strength in particular end markets and what you're seeing in your orders?How I can think about that modeling the mix, the margins?
The way back in the day wheninstrumentation was ripping in the late 90s, it was a very profitable business,and obviously it turned down dramatically. I'm trying to get a feel for the mixto get confidence in the margins in North Americastaying flat in the second half.
You helped a bit there on the internationalmargins. Can you help me understand the mix in the end market as wellespecially in North America?
Tim Pistell
Well, I think you're going to seesome increase in heavy-duty truck first of all.
David Raso
And that's a better than averagemargin business into your North American industrial business?
Tim Pistell
We do a pretty good job in thetruck market overall. And there are some divisions that are very much involvedwith that particular market.
In the last couple of months, we have seen somepositive signs. Especially in class 8 truck builds, our sales have gone up.
Andconsequently, we've seen some nice order entry increases in those particulardivisions. We've seen good growth indistribution.
And as you know, our distribution margins tend to be a couple ofpercentage points better than most of our OEM business. So I think that's theother place where we feel comfortable with the business going forward.
The real ones, I mean the real [crapshoots] that we still have are the semiconductor market and the automotivemarket. So, I think that the margins, the mix should hopefully improve goingtowards the distribution, which should support our margin numbers that we gaveyou.
David Raso
And the order acceleration in North America was more distribution than OEM?
Tim Pistell
Yes, I would say that we probablyare expecting more distribution businesses as part of the mix than we are theOEM.
Don Washkewicz
David, this is Don. One otherthing that I'd just throw in here is that when you look at the operatinggroups, you understand the various operating groups in our structure, notlooking at market segments per se and just the operating groups, with theexception of CIC, the operating groups are double-digit margins across theboard.
So, a movement one place to the other isn't going to make a bigdifference one way or the other on the margins. It's because pretty much allthose margins are over double digits on the operating level.
David Raso
I appreciate the time. Thank you.
Pam Huggins
Thanks, David.
Operator
Your next question comes from theline of Daniel Dowd from Sanford Bernstein.
Daniel Dowd
Good morning.
Pam Huggins
Good morning, Dan. How are you?
Daniel Dowd
I am doing well. So, as I look atthe reporting, the order book actually improving in North America, can you givesome context on if the US rolls into a recession, say, in the first twoquarters of this year, how quickly is that order book likely to deterioratebased on your experience from previous recessions?
Tim Pistell
Dan, this is Tim Pistell. Again,I think that we are, as I say, some people pointed out that we tend to trailthe [ism].
Some people say a month. Some people say three.
I recently have heardsomeone say six months but I think overall that the three months is aboutright. So, again, I don't think whoever's smart enough really to know thosethings, but there would probably be three months lag built into the ism now.
Andas we are indicating, I think there is, a lot of issues that we know and we'rereading everyday on the consumer front. But frankly, so far on theindustrial front we are not seeing it and in fact, in the fourth quarter as youcan see of the calendar we actually improved everywhere, except in internationalwhich was coming off some real high rates.
I know it's a very interesting thingwe've been talking about this several quarters in a row with you people that itseems like -- we are holding up real well and some of these other indicatorsdon't show that. Long winded answer, I don't knowif we would truly roll into a recession.
On the industrial side, we'll see thatfairly quickly, a quarter or quarter later at the most.
Daniel Dowd
Okay. What I take away from thatis this; we are actually in a recession right now.
Even in next quarters'results we might expect to start to see the pain in Industrial North America. Iguess my next question would be, given how much work you have done on lean andthe Win Strategy more broadly, it seems reasonable to expect that decrementalmargins particularly in the Industrial North America business, and this nextcycle should not be quite as bad as they have been observed historically.
Howwould you suggest we think about what the decremental margins could look likeunder declining volume in revenues scenarios in Q1, Q2 and as long as therecession continues.
Tim Pistell
Well, the way we manage thecompany and we've told people this for years. Internally the way that we manageour divisions and our groups is on a incremental or marginal return on sales,and we kind of follow the 30% rule.
So on an upturn we'd like you to see todeliver 30% marginal incremental earnings and/or more, and on the downside thenwe would like you to contain it to 30% or less. Now a couple of things can reallythrow you off there and they are, if you have to do any major restructuring,realignments etcetera, reduction in work force, that can really add to that onthe negative side.
Part of Lean Enterprise is to keep the organization lean andmake sure you have the people you need and not loose a lot of people. The otherpart of that would be inventory; if you're carrying a lot of extra inventory,you got to liquidate that.
Our inventories are at historically low levels. Wedo not have a lot, neither do our customers or distributors, so we do not have that.
So we think that having a reallylived Lean Enterprise now for a five or six years, we clearly are much betterpositioned. And but as I say, we then refer back to the sort of probably the30% [MROS] rule.
Daniel Dowd.
Okay, that's helpful.
Operator
And your next question comes fromthe line of Jamie Cook from Credit Suisse.
Pam Huggins
Hi Jamie.
Chase Becker
Hi, this is actually Chase Beckerin from Jamie today, how are you?
Pam Huggins
Okay.
Chase Becker
Quick question, just in terms ofyour orders, just to ask it in a slightly different way, is there anyway youcan comment sequentially on what you're seeing in terms of the trends?
Pam Huggins
We can only tell you what I justtold you in my comments at the beginning of the call, that for the most parttrending up. But we are up against some tough comparisons which I gave youthose numbers on the call, but other than that I can't talk anymore recent ifthat's what you're asking.
Chase Becker
Okay, and then I guess afollow-up question. If I am looking at your guidance for on the top line on theIndustrial segment, on the International side, it looks like you are implyinggrowth in the second half of about 13% or so which I mean I understand you havetough comps but that's a pretty big drop off in the second half of the year.
Iam just trying to understand if that's something that you are seeing in aspecific market I mean it sounds like everything is pretty robust at this pointbut are you anticipating something in the next six months that's going todeteriorate on the international side?
Pam Huggins
The only think there you have toremember that we don't include currency and the numbers, so.
Chase Becker
Okay.
Pam Huggins
That quite looks like its tailingoff, if you add it back in its pretty close to the run-rate.
Chase Becker
Okay. And then a last questionjust on some brief comments you made on the commercial construction market.
Inyour color you can add just in terms of what you are seeing for activity herein the United States?
Don Washkewicz
On the commercial side?
Chase Becker
Yes.
Don Washkewicz
It's actually been slowing quitea bit. We are not seeing a whole lot of activity maybe some improvement in thesecond half but frankly it's really only, such as the company when it comes tothe CIC Group and a little bit on the hydraulic side where we are actuallyindirectly affected because of construction equipment.
So it's not a major,major part of what's going on. We do think that there is going to be some improvementin the second half where we are actually planning on that, so.
Chase Becker
Okay, great. Thank you very much.
Operator
And your next question comes fromthe line of Robert LaGaipa from Oppenheimer.
Robert LaGaipa
Hi, good morning.
Pam Huggins
Good morning, Bob.
Robert LaGaipa
I guess I just wanted to revisitthe exercise done on industrial North America andindustrial international but this time on the aerospace side. You mentionedthat the development costs have been bit a higher or probably going to continueto remain fairly high at least here in the near term.
And if I look at themargins the 14.1 to 14.5 and obviously that was revised down, but still if youlook at it year-to-date -- year-to-date numbers are 12.7 so it implies an improvementin the second half. Can you just help -- walk me through, where theimprovements going to come and [why] does the fact that the development costsare going to remain high?
Tim Pistell
Yes, this is Tim Pistell, the --I think we have just had a very, very heavy load of these development costs inthe first half, I think we -- the kindof -- I mentioned already its not -- it's certainly laid on 787 as Don alsomentioned. It's also regional jet business, there.
The 350 win is wonderfulnews and that's going to -- come more later we have had some of that. Clearly,we are spending money to win those contracts so, but there just was a lot moremoney spent and this is a customer request and you just have to do it, I meanyou're in the programs you have to do it and to try to keep their programs onschedule.
So, that's what occurred, we seethat really abating right now, I mean a lot of this we think we have incurredand we do see this abating quite a bit in the second half. And that really --the increase in the margins that we're going to have to have in the second halfto get to the guidance we told you that is where it's going to occur, I meanthat's the swing factor.
Robert LaGaipa
Terrific. Second question if Icould, this one might be for Don.
If we look at the balance sheet, obviouslyit's levered its highest amount in about five years, not to say that it's at ahigh level, it's just incrementally higher than it had been at the 30%. Can youmay be just talk about as you sit here today you have completed the acceleratedshare repurchase program, made some acquisitions, et cetera.
Obviously themacro environments have been uncertain at this point, how do think the balancesheet and use of cash moving forward? And what you are seeing on the acquisitionfront, evaluation multiples all that kind of good stuff?
Don Washkewicz
Yes, well, we are looking at alot right now. There are a lot of opportunities out there.
We are certainly --we think the pipeline is pretty full right now, things for us to look at. Thereis a lot of activity going on.
With respect to acquisitions, as you know thatthe main focus in the past has been on dividends. Of course, we want to keepthe dividend increases going.
We've got 51-year record there. And then drawingthe business is going to be a main focus for us, funding the internal growth,innovation and then also acquisitions that keep us at a 5% level.
We've done a few acquisitionsthis year, which brought us to about maybe 2.5% of sales. So we still got about2.5 to go in the second half.
We think we can do that from an acquisitionstandpoint. And then obviously, we have done a lot of share repurchase as youhave noted.
We are going to continue to do share repurchase. At the bareminimum, it'll be to cover any dilution from stock option exercising, and thenwe'll hopefully do more than that.
A lot of that depends on the mixof what's happening at that point in time. Right now, the mix is kind ofshifting toward, I'd say, opportunistic acquisitions and acquisition activity.
Themultiple seem to be, if anything, maybe dropping slightly. I think it's still alittle bit early to see that overall throughout all of the transactions we arelooking at.
I think it's going to take some time for that to whittle down. Butoverall, there is quite a bit in the pipeline right now that we are reallylooking at very closely.
So, we think that we can hit our5% target for the year as we close out the second half. And hopefully, we willdo a little bit more than that, because again, last year, we were little bitshorter than 5%.
I think we did about 2.5% or 3% last year. And we would liketo average about 5%.
So we could do a little bit more of this, this second halfhopefully.
Robert LaGaipa
And just quickly on thatvaluation multiple comment, was that pretty much broad across the regions ordoes that apply to maybe one specific region?
Tim Pistell
This is Tim. And I would say thatNorth America, Europe are aboutthe same.
And here is the situation; the no question that people cannot get thefinancing that they were getting earlier, people will not lever up. And so,that clearly will drive the multiples down over time.
And that is a fact.That's a reality right now. What has to occur, though, is there is a lot ofsellers with high expectations that were set earlier and it will take them awhile to re-adjust their thinking.
A lot of activity, though, as I say. Theactivity level has not slowed down.
But we are going through this adjustmentperiod. And that's the same both in United States and in Europe,Asia.
Every situation remains unique.
Robert LaGaipa
Terrific. Thanks very much.
Pam Huggins
Thank you.
Operator
And your next question comes fromthe line of Mark Koznarek from Cleveland Research.
Pam Huggins
Goodmorning, Mark.
Mark Koznarek
Hi,good morning. A question having to do with some of the comments that JackMyslenski made a few minutes ago with regard to the margin improvement that hasoccurred in the international arena.
And it was fascinating that he said that you've captured the 6 percentage points from wins and thenan extra 3 from deliver system. And itstrikes me that that delivery system, a lot of that is sales forcereorganization, and that's a trigger.
You haven't pulled that trigger here in North Americayet. As we talk to your distributors, they still complain that there is a lotof redundancy across the different groups that have different salespeople coming to see them, rather than somebody coming in and representing onephase to Parker-Hannifin.
So this is kind of a long-winded preamble, but isthere an opportunity to pick up 3 percentage points more of the profit marginhere in North America as you ultimately execute thatsales force reorganization over here in North America?
Don Washkewicz
Mark, this is Don and I'll letJack comment to if you like in a moment. Just to let you know that there hasbeen an evolutionary change going on here in North Americaas well as the rest of the world.
For instance, we’ve organized in the mobilepart of our business under one entity, so we've got everything pretty muchorganized in a similar type of structure as we would see in a sales company in Europe.We have that going on in North America. Our truckbusiness has also been organized along those same lines.
So it would be unfair to say thatwe haven’t done anything in North America, there hasbeen a lot that has been done. A little less has been done on the Industrialside of the business as compared to the mobile side of the business.
So therewould be possible some opportunities there, we're not going to really try toquantify it at this point and I think just leave it to say that its more of anevolutionary thing that will be happening gradually over time as opposed tosomething that we're going to have try to get done next year, because we wantto go slow. We’ve been very successful in North America operating in the way we are.
We recognize there were someopportunities to present ourselves more as one Parker to that customer and wewant to do that, wherever we possibly can. So there will be changes made, butit'll be more slow coming.
Mark Koznarek
Okay. And then actually just onefollow-up on the tax-rate, the guidance is 29% for the year and the first halfwas only 28% -- 28.1%.
So does that mean that we expect a more significant taxrate in the second half or are you really just rounding for that 29%?
Tim Pistell
Mark its Tim. There were somediscrete items that did happen in the first half, in particular in Europe,people changing tax rates.
We had to make some adjustments as they loweredtheir tax rate that helped us get there, and so that is why the rate goingforward there. Clearly in this day and age on taxes, there is a lot ofindividual things that one must do to affect that rates and it's just a questionof how successful can we implement somebody's tax plans.
So I would hope thatwe can implement some. Once again congress couldn't get to the R&D credits.
Mark Koznarek
Right.
Tim Pistell
Is a big example that we are onthis ridiculous schedule of, they do, it's like six months, 18 months. They gotcaught up in all and too many other things and did not re-up the R&Dcredits.
Now we fully expect them to do that at a later date. So unfortunatelybut there is a lot of [to-ing and fro-ing] of discrete items and so we got toguess, hopefully we've taken a conservative look and we'll be able to get someof those on a go-forward.
Mark Koznarek
Great, Tim. Thanks a lot.
Tim Pistell
Okay.
Operator
And your next question comes fromthe line of Andy Casey from Wachovia Securities.
Pam Huggins
Good morning, Andy.
Andy Casey
Good morning everybody. Firstquestion is, can you help me understand - I'm trying to understand there isother expense line.
It had a sequential decrease from Q1, but the impliedguidance expects a pretty descent acceleration in the second half. Can you helpme understand the puts-and-takes going on there?
Pam Huggins
Andy, as you well know in thatparticular category there a lot of things that affect that. But one other thinghistorically, if you go back you would see that currency was positive for us inthat and it's just beginning to turn negative in that particular category, soyear-over-year you are seeing a big change as a result of that and thatprojected going forward.
Andy Casey
Okay, so the primary one iscurrency for that.
Pam Huggins
That's right.
Andy Casey
Okay. Now could you talk alsoabout the input cost trends here you maybe seeing because there is a lot ofmovement in some of those spot markets for some of the stuff that you consume?
Don Washkewicz
Well, as far as the rawmaterials, are you saying Andy?
Andy Casey
Yes.
Don Washkewicz
I would say there is still somepressure on some of the raw materials for instance the copper base materialsand so forth, still some pressure there some of the nickel base materials. Butmany of the other ones have plateaued okay, over the last six months.
And ifanything right now, I would say we are not sure what's going to come, becausewe know the price of oil has gone up to $100 a barrel and now it's on thepetroleum base materials. I think if we had a concern it would be what's goingto happen to those materials overtime.
I know that the President just overtrying to get the spicket turned on over in Saudi Arabia, so maybe that will help bring thatprice down a little bit. But that would be where my concern would be if yousaid what's going to happen in the 12 months as far as materials, more so onthe polymers and the rubber based plastic and so forth.
Andy Casey
Thanks a lot Don, and while youare there Jack, good luck in retirement.
Jack Myslenski
Thank you.
Pam Huggins
Thanks Andy, thank you. And we'vetime for just one more question.
Operator
Your last question comes from theline of Jeff Hammond from KeyBanc Capital Markets.
Jeff Hammond
Hi, good morning. Hey Jack youmentioned that the areas of strength you have seen in what's driving Europe,any pockets or weakness either on a country or end market basis?
Jack Myslenski
Yeah, the cars and light trucksare still not doing real well in Europe, so we have had some decline in thatparticular area which affects a couple of our groups filtration and connectors,that's been one place that's been [light]. There are -- machine tool businessis not roaring, hasn't been terribly bad, but it's been affected because thereis not a whole lot of new automotive plants being built and consequently it'shad a spillover on the machine tool builders that are in primarily Germanyand in Spain.Interestingly enough there is quite a few manufacturers of equipment for theautomotive markets in Spainand consequently we have been struggling there because of that.
But outside ofthat most of the business stays pretty strong, I can't pick anything elsethat's been negative.
Jeff Hammond
Okay. And then just moving backto North America, can you give us a better sense of howmuch differentiation or bifurcation there is between your growth rates anddistribution versus the OEM side?
Jack Myslenski
You almost got to go segment-by-segment,Jeff, its little bit difficult. Our numbers have been very strong on thedistribution side, and I would say they are at a faster rate than what we havebeen experiencing with the OEMs, but to quantify it, I would rather not.
Justit's too difficult because the change pretty much in the construction marketsbeen okay but it hasn't been booming. Ag has been good, but it hasn't beenbooming.
So, I would say that if we are looking at a faster growth, it would bein distribution as opposed to the OEM.
Jeff Hammond
Okay.
Jack Myslenski
So, I know that doesn't give youa lot of flavor, but I think that's where we are looking at in the second half.Tim?
Tim Pistell
This is Tim. Just one before weclose this out right now.
We have not talked about either Asiaor Latin America at all. I think this has all beenmanagement by exception here, which is what we do.
But just to let you knowthat both of those regions are extremely robust, almost right across the board.And we foresee that continuing for some time to come as well.
Pam Huggins
Right. And I just want to commentas well that, yes, you look at the guidance going forward and we have upwardlyrevised our guidance.
So, we are confident going forward that things are goingto be good for fiscal year 2008. And with that, I would like to just turn itover to Don who has a few closing comments.
And I would like to thank you foryour participation in the call today.
Don Washkewicz
Okay. Thanks, Pam.
We are so -- Ithink, basically what we have said so farthen is that we're pretty much on our way to another record year at Parkerbased on everything we can see. This quarter, we produced record second quarterresults in sales and earnings and net income and earnings per diluted share.
As a result of that, we feel veryconfident and felt very confident in increasing our guidance, which now is$5.15 to $5.40 per diluted share. So, I think that that's all very positive forthe company.
Just a couple of additionalcomments, I want to thank everyone that's on the call for your time and for thequestions. The results certainly that we are achieving are a direct result ofthe win strategy and all the activities that have gone on to evolve the roundand win strategy over the last seven years, and it's going to continue to be anongoing effort, and there will be continued gains from the execution of thatstrategy.
Again, our main goal, just toremind everyone, is to maximize ROIC. And what we do want to do is to maintainthe top quartile position relative to our peers.
So, that's what our goal is,our overall goal, and everything we are doing is trying to drive us to that tomaintain that top quartile position. Now, we have a strong organicgrowth rate, and it's about 5% now.
And that's been pretty amazing I think whenyou look at the company, because with all the soft markets that we've looked athere certainly in North America to maintain us a 5%organic rate has been gratifying. And there is, of course, as anaddition to the growth that way through acquisitions, and we're going tocontinue to pursue acquisitions.
As I mentioned earlier, there is a number ofthat -- quite a few that we're looking right now. And so that will continue onthroughout the balance of this fiscal year.
Lastly, working to continuing togenerate strong cash flows, reaching new records there as well, and that ofcourse is driving earnings per share north as well. On behalf of the leadership team,I just want to also thank Parker's worldwide team of employees.
I know thatthere is number of them that are listening in and obviously very interested inwhat's happening in the company from around the world. So, I want to thank themfor their accomplishments and for continuing to drive the company's growth andprofitably grow their company year-over-year.
Once again then just for thepeople on the call, I want to thank you for your participation. We certainlyappreciate all the interest that you've had in the company.
And if you have anyadditional questions throughout the balance of the day, Pam will be around toanswer those. So, have a nice day.
Thank you very much.
Operator
Thank you for your participationin today's conference. This concludes the presentation.
You may now disconnect.Have a wonderful day.