派克漢尼汾 (PH) 2016 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter one 2016 Parker Hannifin Corp's earnings conference call. (Operator Instructions). As a reminder, this call is being recorded.

I would now like to turn the call over to Mr. Jon Marten, Executive Vice President and Chief Financial Officer. Please proceed, sir.

Good morning and welcome to Parker Hannifin's first-quarter FY16 earnings release teleconference. Joining me today is Chief Executive Officer, Tom Williams, and President and Chief Operating Officer, Lee Banks. Today's presentation slides together with the audio webcast replay will be accessible on the Company's investor information website at phstock.com for one year following today's call.

On slide two, you will find our Safe Harbor disclosure statement addressing forward-looking statements as well as non-GAAP financial measures. Reconciliations for any reference to non-GAAP financial measures are included in this morning's press release and are posted on Parker's website at phstock.com.

Today's agenda appears on slide three. To begin, our Chief Executive Officer, Tom Williams, will provide highlights for the first quarter of fiscal year 2016. Following Tom's comments, I will provide a review of the Company's first-quarter FY16 performance together with the revised guidance for FY16. Tom will provide a few summary comments and then we will open the call for a Q&A session.

At this time I will turn it over to Tom and ask you to refer to slide number four.

Thanks, John, and welcome to everyone on the call. We appreciate your participation today. I am going to take a few minutes to review the quarter and touch briefly on some of our end markets. I will also provide an update on the new win strategy.

To start, a few comments on our first quarter, it continues to be a very tough environment in many of our markets. We are experiencing the negative effects of the strong dollar and we witnessed further deterioration in key end market demand. We have continued with actions to adjust to these conditions. These actions include reduced work schedules and tight control of discretionary spending in addition to the previously announced actions we have underway with regard to restructuring and our simplification efforts under the new win strategy.

Sales declined 12% in the quarter as the effects of the strong dollar negatively impacted us by approximately 6% while acquisitions were slightly positive resulting in an organic sales decline of 7%. Order rates declined 11% in the first quarter compared with the same quarter last year reflecting ongoing market weakness particularly in the natural resource related markets.

Despite the magnitude of the decline in sales, I am very pleased we delivered total segment operating margins of 14.5% or 15.3% on an adjusted basis.

As many of you are familiar for some time now, we have been raising the floor and ceiling on margins through past business cycles. Our Q1 results represent the best segment operating margin performance that we have had in recent history given this tough macro environment and represents decremental operating earnings of just 22% on an adjusted basis.

It also represents a sequential improvement of 40 basis points in adjusted segment margins from the level we achieved in the fourth quarter. There are three main drivers that impacted our margin performance.

First was savings from restructuring we have done in prior years. Next, the rapid response that we did on cost containment. And then lastly, the immediate benefits from our simplification initiatives.

I want to take a moment to thank our entire global team for demonstrating such agility and adapting to a rapid change in demand.

Earnings per share for the quarter were $1.41 or $1.52 adjusted for business realignment expenses. Operating cash flow for the quarter includes $200 million discretionary contribution to the US pension plan. Excluding this contribution, operating cash to sales was 7.1%.

As I have said before, Parker is committed to being a great generator and deployer of cash.

During the first quarter, we repurchased $310 million worth of Parker shares. We have now repurchased $1.64 billion under our previously announced $2 billion to $3 billion Parker share repurchase program over two years which began in October 2014. We completed two acquisitions in the quarter providing approximately $50 million of annual sales including President Engineering Group in the UK, a leading producer of cryogenic valves.

We also completed an equity investment in Exosite LLC, an industry-leading software provider to enable industrial Internet of Things applications and services. We see tremendous opportunity for Parker to generate service revenues and have assigned a seasoned Parker leader to spearhead that aspect of our growth strategy.

Moving on to a discussion on key market trends. We saw continued softening in some key markets that are important to our businesses. Specifically, natural resource related markets like oil and gas, agriculture, mining and construction equipment saw continued weakness. Our distribution channel was also affected especially those distributors who are exposed to oil and gas. Although we knew these markets would be a drag on our first-quarter, some of these markets contracted a stronger than expected rate.

These challenging market conditions outweighed positive growth trends in other markets such as power generation, heavy duty truck, rail and aerospace and Lee Banks will provide some more color on the end markets in the Q&A portion of the call.

Now switching to our outlook, for fiscal year 2016 we are revising our guidance for earnings to the range of $5.30 to $5.90 per share or $5.80 to $6.40 per share on an adjusted basis.

Regarding our revised sales guidance, the following are the key drivers. First, order entry levels are weaker than anticipated and have worsened sequentially through the quarter. Second, we are not forecasting any meaningful recovery in our natural resource related end markets through the remainder of our fiscal year. Third, we are now anticipating more softness in emerging markets and our distribution channel.

These factors mean that our current guidance assumes a 5% for the whole Company year-over-year decline and second half organic sales whereas previously we had guided to a positive 2.7% increase. We continue to aggressively manage costs in this environment and as our guidance indicates, maintain strong decremental margin performance.

As many of you know, we introduced the new win strategy at our investor day last month. The week before that we met with the top 300 leaders of our organization to share the details of how we plan to take Parker's performance to the next level. I am excited to see how energized our team is by our plans and I'm even more optimistic that we can achieve our long-term goals.

We are targeting 17% segment operating margins and an organic sales target to grow 150 basis points faster than industrial production growth by fiscal 2020.

Importantly, we have changed our incentive compensation program with an increased emphasis towards rewarding for growth and we have pushed this program deeper into the organization.

The new win strategy has established four broad goals and includes detailed initiatives for each. I would like to just take a minute to outline a quick summary of those key goals.

First is engage people. It is all about high engagement and ownership by our Parker team members which will drive exceptional performance. Next is premier customer experience. So moving from more of a service mindset to creating a great customer experience enables

The next is profitable growth where we are implementing strategies to grow organically 150 basis points faster than the market. And then financial performance, where we are going to be a top quartile financial performing Company versus our diversified industrial proxy peer group with year-over-year earnings growth.

Our new annual report goes through each of these goals in detail outlining our strategies and measures of success. As we have detailed here, many of these initiatives such as simplification are already underway. With the introduction of the new win strategy now complete, our teams are hard at work building detailed execution plans to achieve our goals. We are excited about the opportunities that will position Parker as a top quartile performing Company compared to our proxy peers.

And for now, I will hand things back to Jon to review more details on the quarter.

Thanks, Tom. At this time, please refer to slide number five. I will begin by addressing earnings per share for the quarter.

Adjusted earnings per share for the first quarter were $1.52 versus $1.89 for the same quarter a year ago. This excludes business realignment expenses of $0.11 and compares to $0.04 with the same quarter last year.

On slide number six, you will find the significant components of the reconciliation from adjusted earnings per share of $1.89 for the first quarter FY15 to $1.52 for the first quarter of this year. The impact of fewer shares outstanding equated to an increase of $0.13 per share. Reductions to adjusted per share income include lower adjusted segment operating income of $0.41 per share driven by the impact of foreign currency and a continued weakening of the end markets demand, and net increase in corporate G&A, interest and other expense that totaled $0.09 per share due largely to the increased debt issuance expenses from FY15, and lower currency transaction gains booked in the current quarter.

Moving to slide number seven with the review of the total Company sales and segment operating margin for the first quarter, total Company organic sales in the first quarter decreased by 7% over the same quarter last year. There was a 0.4% contribution to sales in the quarter from acquisitions; currency impact as a percentage of sales was slightly higher than planned equating to a negative impact on reported sales of $187 million or 5.7% in the quarter.

Total Company segment operating margins for the first quarter adjusted for realignment expenses incurred in the quarter was 15.3% versus 16.1% for the same quarter last year.

Restructuring costs incurred in the quarter were $22 million versus $6 million last year. The lower adjusted segment operating income this quarter of $438 million versus $525 million last year reflects the meaningful impact of reduced volume and unfavorable mix from the continued weakening of several industrial end markets.

Moving to slide number eight, I will discuss the business segment starting with diversified industrial North America. For the first quarter, North American organic sales decreased by 11.3% as compared to the same quarter last year. There was modest impact from acquisitions and a negative impact from currency of 1.5% in the quarter.

Operating margin for the first quarter adjusted for realignment costs was 17.2% of sales versus 18.0% in the prior year. Realignment expenses incurred totaled $8 million as compared to a nominal spend in the prior year. Adjusted operating income was $221 million as compared to $264 million driven by reduced volume as a result of the softening trends in key end markets.

I will continue with the diversified industrial segment on slide number nine. Organic sales for the first quarter in the industrial international segment decreased by 5.8%. Currency negatively impacted sales by 12.7%. Operating margin for the first quarter adjusted for realignment costs was 13.6% of sales versus 15.5% in the prior year.

Restructuring expenses incurred in the quarter totaled $12 million as compared to $6 million in the prior year. Adjusted operating income was $141 million as compared to $195 million which reflects the impact of the foreign currency changes as well as weaker end markets.

I will now move to slide number 10 to review the Aerospace Systems segment. Organic revenues in Aerospace increased 2.5% for the first quarter. Currency posed a modest negative modest 0.6% percent. The segment sales growth for the period was driven by higher commercial and military aftermarket sales volume.

Operating margin for the first quarter adjusted for realignment costs was 13.9% of sales versus 12.2% in the prior year. Realignment expenses incurred in the quarter totaled $2 million. Adjusted operating income was $76 million as compared to $65 million reflecting be favorable mix of aftermarket sales volume in the quarter combined with reduced development costs as a percent of sales.

Moving to slide number 11, with a detail of quarters changing by segment. As a reminder, Parker orders represent a trailing average and are reported as a percentage increase of absolute dollars year-over-year excluding acquisitions, divestitures and currency. The Diversified Industrial segments report on a three-month rolling average while Aerospace systems are based on a 12-month rolling average. Total orders shifted to a negative 11% for the quarter end reflecting the further softening in natural resource related end markets.

Diversified Industrial North American orders decreased to negative 12%; Diversified Industrial International orders decreased to negative 8% for the quarter. Aerospace Systems orders decreased to negative 16% for the quarter against notably very high prior year comparables.

Slide number 12, we report cash from operations. For the first quarter, cash from operating activities was $5 million but when adjusted for the $200 million discretionary pension contribution made in the quarter, cash from operating activities was 7.1% of sales. This compares to 8% of sales for the same period last year. The significant uses of cash during the quarter were $396 million returned to our shareholders via repurchases of $310 million and dividends of $86 million. $67 million was expended for acquisitions closed during the quarter; $39 million for CapEx equating to 1.4% of sales for the quarter.

On slide number 13, the revised full-year earnings guidance for FY16 is outlined. Guidance is being provided on an adjusted basis.

Segment operating margins and earnings per share exclude expected business realignment charges of approximately $100 million which are forecasted to be incurred throughout FY16. Total sales are expected to be in the range of negative 11.3% to negative 7.7% or negative 9.5 at the midpoint as compared to the prior year. Adjusted organic growth at the midpoint is negative 7.2% currency in the guidance negatively impacts sales by 2.7% which is nearly all attributed to the Industrial International segment of course.

We have calculated the impact of currency to spot rates as of September 30, 2015, and we have held those rates steady as we estimate the resulting year-over-year impact for the upcoming fiscal year 2016.

For total Parker, adjusted operating margins are forecasted to be between 14.6% and 15.0%. This compares to 14.9% for FY15 on an adjusted basis. As Tom mentioned, we are very pleased to be guiding to this level of adjusted segment operating margins given the magnitude of the end market softness and order decline. The guidance for below the line items which includes corporate, admin, interest and other is $511 million for the year at the midpoint.

Full-year tax rate is projected to be 29%. The average number of fully diluted shares outstanding used in our full-year guidance is 138.6 million shares.

For the full year, guidance on an adjusted earnings per share basis is $5.80 to $6.40 or $6.10 at the midpoint. This guidance excludes business realignment expenses of approximately $100 million to be incurred in FY16. Savings from these business realignment initiatives continue to be projected in the amount of $70 million which are reflected in the segment operating margins provided.

Some additional key assumptions for full-year 2016 guidance are sales are divided 48% first half 52%, second half; adjusted segment operating income is divided 46% first half, 54% second half; adjusted EPS first half versus second half is $2.68 for the first half, $3.42 for the second half; Q2 adjusted EPS is projected to be $1.16 per share at the midpoint and this excludes $0.20 of business realignment expenses.

On slide number 14, you will find a reconciliation of the major components of the revised FY16 adjusted EPS guidance of $6.10 per share at the midpoint from prior fiscal year 2016 EPS of $7 per share. Increases include $0.19 from reduced other expense and $0.10 from fever shares outstanding. Key components of the decrease include $1.14 reduction in segment operating income reflecting further reduced volume and unfavorable mix forecasted with key industrial end markets and finally, $0.05 from increased corporate G&A and interest.

Please remember that the forecast excludes any future acquisitions, divestitures that might be closed during FY16. For consistency, we ask that you exclude restructuring expenses from your published estimates.

This concludes my prepared comments. Tom, I will turn the call back to you for your summary comments.

Thanks, John. We are operating in a difficult environment but as the first quarter demonstrates, we have responded well. I am pleased with the progress we are making on our restructuring initiatives which remain on track for the year. We also continue to find new opportunities to streamline operations through our simplification initiatives.

What I am most encouraged by is the response of our partner team members. They are stepping up to the challenges before them and are embracing the changes we have initiated to build a stronger partner. I'm confident that we have a bright future ahead of us and I look forward to sharing with you our progress throughout this year.

So at this time, we are ready to take questions. So, Sue, you could go ahead and start us off.

(Operator Instructions). Stephen Volkmann, Jefferies.

Good morning, guys. I am wondering if we could dig in a little bit just on the change of the guidance sequentially. Obviously things sort of deteriorated through the quarter here. I think you made a comment that it kind of got worse as the quarter went along. And I am wondering if you could just flesh that out a little bit and if I am right about that?

But more importantly, what really deteriorated? Do you have more energy exposure than you originally thought? It seems like the stuff that has not commodity related has been fairly stable but correct me if I am wrong there. Maybe just a little bit more color on how this progressed through the quarter and what is really driving it?

Steve, this is Tom and I am sure that is the key question everybody has and I will start off with giving you kind of an overview of how our thought process changed and what was behind revising the guidance. Then I'm going to hand it over to Lee to go ahead and go through the markets in more detail.

What really changed during the quarter was order entry levels weakened more than we anticipated and September was much worse than we had expected. And as we had mentioned at the investor day those of you that were there, September is always a key month. It is really a key indicator for how the quarter is going to be so July and August are always somewhat suspect because of the levels of vacation and holidays between North America and Europe. September is your first good indicator for the quarter and also it is a really good indicator for what the rest of the year potentially is going to look like.

So September turned worse. That was the first influence. Also based on the rollup that we have gotten from our divisions, our customers talking to our distributors, we are not forecasting any kind of recovery in the natural resource related markets in the second half of our year which we originally were forecasting some kind of recovery there. So oil and gas, construction, ag and mining are soft and actually are softer than we had expected and they are going to continue that way through the remainder of the fiscal year.

We are also anticipating more softness in the emerging markets. We had anticipated China and Brazil, they were soft. They have softened worse through the course of the quarter. And then what you were referring to, Steve, about kind of the oil and gas impact, clearly oil and gas impacted North America the most but there is clearly a knock on effect that is felt throughout the rest of our end markets and particularly for our distributor channel which is a big part of the Company, it felt the reduction in oil and gas and it has felt it across the whole board. So we have seen distributions soften quite a bit in the quarter and that is a change for us from what we think the full-year is going to be.

So in general, we had forecasted softening in the first half with some small lift in the second half. That was our original guidance. So now what we are saying is that the first half is going to be softer than we thought before. We don't see any kind of recovery in the second half and the second half will be soft as well.

So with that kind of as an overarching summary, I'm going to let Lee go through the end markets in more detail.

Okay, Tom. Thanks. Steve, so just kind of reiterating what Tom said, if you look at it, it is continued softness in some of these natural resource driven markets and then the continued softness regionally by country in Europe, China and Brazil and let's not forget about currency continues to be a major headwind.

If we look at North America maybe starting there, we mentioned in Q4 a slowdown in distribution and it is clear that that slowdown continued in Q1. I would say it was largely attributed to those distributors with exposure to oil and gas but you couldn't help but see a knock on effect in some other distribution with some of their order entry and business.

We do continue to see destocking in the channel. As you know, our best bet is we will continue to see that destock through Q2. As I mentioned earlier, distribution outside of oil and gas in some areas is okay and then some areas it is just moderate to slightly negative. So maybe it is an effect of the strong dollar in some key markets. It is certainly not as robust as we saw last year.

Then if I look at oil and gas, we continue to see contraction across all sectors but specifically the upstream sectors. Offshore activity and land-based activity continue to be very soft. The last rig count numbers I saw was down 57% versus prior year so a significant reduction.

I think the one thing even though business is soft, we are encouraged really by some of the wins with new products we have had in these industries and we are seeing great opportunities in service businesses that we have launched and are working with some of these key customers.

Agriculture, we talked about earlier continues to be very soft. And energy -- this is really around power generation, we do continue to see positive trends there both in traditional and renewable. In the traditional, it is really not new plants being added it is a conversion from coal to natural gas and that has been a great opportunity for us. And we are also very encouraged by progress with our energy storage business unit which we've highlighted before in the past.

On heavy truck, Class A build continues to be strong although somewhat of a more modest rate here in Q4. But we are still expecting progress for 2015 over 2014 and the forecast we have for 2016 continue to look good. This is another industry where we continue to experience growth from the positive markets but also with some of the technologies that we have introduced in emission controls in that industry.

On mobile, really off-highway continued softness in mining and construction.

Turning to Europe, general distribution is up year-over-year but like North America, those areas impacted by oil and gas are a major headwind. We have some distributors near the North sea that are off as much as 55% to 60% so significant impacts there. But from a country standpoint, we do see positive year-over-year performance in countries like Germany, Spain and the Netherlands from an industrial standpoint.

On construction, we do see positive trend in higher end domestic construction equipment markets but those customers that are focused really around export, their businesses are badly depressed mainly by what is happening in Russia and some of the other emerging markets in the (inaudible).

Oil and gas as I mentioned earlier, that activity is very slow. We have seen a lot of major capital projects in the Middle East and North Sea have been delayed and moved out for a significant amount of time.

Agriculture, continued softness, issues continue to be compounded by really what is happening in Russia and Ukraine.

And then in truck, there really continues to be excellent strength in the heavy end of the market.

Let me just turn to Asia now if I can. We do see continued contraction in China. I think that is a little slower at this point than what we had expected and we are not really forecasting anything significant there in general. We have seen continued weakness in construction equipment markets there. I'm not sure if you can go to zero but it is getting close. Distribution is still growing really through added locations but as a whole I would say we are flat to moderately down.

Power generation I mentioned earlier. That it still is a positive for us and our participation there. I would say one key area has been rail. China has really stepped out as a leading provider in both high speed and metropolitan transportation and we have been out working with those customers closely and have had some great success there.

Lastly, I will just touch on Latin America. I think really the story continues to be Brazil, significant currently devaluation, continued contraction in GDP. We do see positives again this common theme around power generation, we see it throughout Brazil but also in countries like Chile, Colombia, etc.

Heavy truck and traction, it is really down 50% year-over-year in Brazil. Same thing continued softness in construction equipment and agriculture. But we are also like North America, we have made some really great progress in maintenance and services businesses with some of the CapEx that has already been deployed around oil and gas.

You got a lot there, Steve.

I appreciate. Just one quick follow-on. Can you guesstimate how much of the distribution exposure is in energy? Then I will pass it on.

I wouldn't really be able to guesstimate right now. I would say those distributors around Southwest, Gulf and Western Canada have more exposure but I would be hard-pressed to give you a number right now.

Okay. Thank you.

Jeff Hammond, KeyBank.

Good morning, guys. So your decremental performance very good in the quarter and it seems like in the guide you are seeing that as sustainable. So I guess as you get further into this downturn, what is your confidence level you can sustain that? And maybe just speak to what you think you are doing differently in the cost structure maybe this cycle versus last cycle to be able to hold those decrementals?

Jeff, I think one of the things that we are most proud of is our ability to maintain these margins as Tom said given the downturn that we saw in Q1 and like you said as we are foreseeing for the balance of the fiscal year.

As we have been kind of speaking about in many of our forums, we have done quite a bit of restructuring last year and the year before. That prior restructuring is serving us very well as we continue to get the savings from that this year and throughout the balance of the year.

We also have been responding very quickly at each one of our operations throughout the world to the changing market conditions and we are much quicker responding today than we were in the prior downturns and that is something that is serving us very well.

Lastly, with the new win strategy and our simplification efforts that we talked about last year, that has been kicking in in a very, very good way for us. We are very enthusiastic about our ability to maintain our margins in the area that you see in our guidance and our simplification efforts we see being a very powerful driver for us from a margin standpoint going forward here. And that is one of the very important elements of the financial performance in the new win strategy that we are going to be focusing on going forward here.

So I would say that those are the three major changes and things that are a little bit different than we have seen in prior downturns for us.

Okay, great. And then you mentioned September worsening. Can you just maybe speak to how that trended into October? And then also on the distributor destocking, I think Lee, you said you thought that continues through calendar year end. What is really in the guidance around distributor stocking?

Jeff, this is Tom. I will start first with September. So September worsened. We saw July come out about how we expected. August turned a little bit better so we were a little bit optimistic, then September got worse and that continued. Basically what we have seen in October is reflective of what we have done in our revised guidance.

And I guess just on the destocking part, what is in the guidance is destocking finishing end of this calendar year. So end of Q2, early into Q3.

Okay, thanks.

Jamie Cook, Credit Suisse.

Okay, good morning. I guess my question centers around just pricing as well as material costs. I think there is increased scuttle in the channel that pricing has deteriorated. So I'm wondering sort of if you can give some color on what you are seeing and what your assumptions are in terms of pricing for 2016? And then also what your assumptions are on the material cost side? Thanks.

Jamie, it is Lee. So overall, you are right, it is a challenging environment on pricing and it is a favorable environment on material costs. So I would say in our guidance, it is just basically flat going forward. It is going to continue to be a challenging environment. That is the best way I can characterize it for you.

But I guess when you think about the -- is it specific is a certain end market or type of customer or do you know what I mean or can you talk just more broadly competitively like what you are seeing, just any color I guess besides it is bad.

I would say pricing is most challenged around those markets that are down significantly. So if you think about the oil and gas markets we talked about where there is just really no significant demand right now, we continue to have great pricing opportunities in markets outside that but there is some momentum in some of those key end markets that do make it a challenging environment. Then plus coupled with the fact that you have this deflationary effect going on with materials, it just makes it -- we are still positive but it is a challenging environment.

Then I guess just my second question just relates to capital allocation. I know this year I mean I think your guidance implies your share count doesn't change from where we are in the first quarter. Can you just talk about has there been any change in priority or acquisition, or acquisitions popping up as more favorable? I don't know if pricing is getting any better relative to like a year, 12 to 18 months ago when the pricing environment on acquisitions just wasn't in your favor.

Jamie, this is Tom. I will start with the capital allocation priorities. So they haven't changed versus the dividends. We want to maintain that increased record and our target is 30% payout to net income and we are at that and we are above that on a going the last 12 months, we are quite a bit above that. The next would be organic growth to fund CapEx for organic growth and innovation as well.

Then when we look at share repurchase and acquisitions, it is really looking at it on a case-by-case basis and making the best decision that generates the best long-term value for our shareholders looking at those two in comparison.

On the share side, you saw what we did in the quarter so we bought $310 million of shares. Approximately $112 apiece so we are now at $1.64 billion so we are 82% of the way to the low end of our commitment and we are still committed to that $2 billion to $3 billion range and I think we are making good progress on that.

On the acquisition front, we continue to work that pipeline but just by nature how acquisitions work, they are going to be lumpy, they are going to be difficult for us to predict and give you any kind of visibility to. But I would tell you valuations still from our perspective are high and we are disciplined buyers and so there has been several properties that we have passed on because of that. And we will just continue to work it and we will have to see what yields out of it but again it is looking that in conjunction with share repurchases and making the best long-term decision there.

Okay, thanks. I will get back in queue.

John Inch, Deutsche Bank.

Thank you. Good morning, everyone. So, Jon, you called out unfavorable mix as part of the walk from the $7.00 to the $6.10 within the $1.14 drag versus your prior expectation. And then, Lee, you just said that you are not expecting any pricing so I want to square those two. In other words, what has actually happened with respect to mix in three months that warranted kind of calling that out especially if price is only flat. So unfavorable mix implies there is price degradation our realization in some manner. Could you just talk to that and maybe the context? Is it significant in the $1.14? I mean just trying to make sure I am triangulating all these points.

Sure. I think when I talked about mix I talked about the change in volume. And as we go forward and we look at all of our end markets as the volume in the higher-margin end markets reduces, that is having an impact on our margins that outweighs all the other end markets that we have. And so historically, John, North America has been progressing very well in terms of our sales growth over the last several years. What we are starting to see now and you see it in our orders and you see it in our guidance is that in North America, sales increases this is actually now of course decreases are more pronounced in North America than they are in our international industrial markets and so from a mix standpoint on that volume, we are being impacted disproportionately.

So you are saying basically lower volume in North America is translating into lower realized kind of overall profit within industrial? I think that is what you are saying.

Right, more of a volume issue than a pricing issue here for us.

So in other words, Jon, when you looked at North America rolling orders down 11%, is that all volume or is there also a little bit of -- like is that all a unit volume or is there any kind of price degradation that bakes into the 11%?

It is primarily almost all volume, it is not pricing, John.

Okay. So then Lee when you said pricing is not going to be flat can you just remind me what was that versus? Did you previously think it was up like 0.5% or something or is it kind of squaring with Jon's comments, not really that material?

I'm sorry, John I lost you at the last half there but (multiple speakers)

Jon is making the point that it is kind of a change your which is fine, it is volume and there is associated decrementals. But you made the comment to Jamie that now you expect price to be flat. So I'm just trying to understand, what was that versus? In other words, you had been hoping that price was going to improve but it is now flat or it has actually gone a little softer? That is all. I'm just trying to make sure I am dotting all of my i's.

Just to kind of try to connect the dots here for you, when Lee was talking about pricing being flat, we are really talking about our process inside the Company where we take every part that we ship today and every single one of our divisions and we compare the price of that part today to that price of that same part that we shipped at the exact same time last year. And we calculate a sales price index and in that sales price index that Lee is talking about, it is basically flat and that is the flat pricing that we are seeing overall that Lee I think was referring to. Does that help?

Lee also made the comment that pricing -- he almost implied it was increasingly perhaps challenging. The reason I am harping on this is price is one of these buzzwords right now that people are throwing out and the companies are sort of not suggesting including your own that there is really that much realized priced degradation versus the chatter of potential. I just want to make sure you are really seeing (multiple speakers) more substantial.

So realized priced degradation is not something I worry about for the Company. There are certain end markets that are price challenged and there are certain markets that are not price challenged. When you kind of sum it up across the board, it is kind of a zero sum game. But I don't worry about price degradation as a whole for the Company.

Just lastly, $70 million of restructuring savings, how does that delineate over the next three quarters?

It is a total of $20 million in the first half and $50 million in the second half, John.

Okay, got it. Thank you very much.

Josh Pokrzywinski, Buckingham Research.

Just as a follow-up to Jeff's question earlier on the decremental margin management. It looks like as it pertains to the 2Q guide you guys actually do a little better managing that sequentially. And I would think with all of the comments around destocking particularly in distribution where you have some better mix, presumably you are also destocking in your own facilities so maybe absorption is a little wider.

I would imagine that something between some of the input cost deflation, restructuring savings are helping bridge that. Can you maybe talk about how that squares out either by 1Q, 2Q, first half, second half just so we can help square up volume versus some of the other discrete items coming through?

Yes, I think that it is really hard to articulate very quickly the depth and breadth of the restructuring that we have done in the prior years and how that is impacting as the year goes on our decremental margins.

One thing to just point out, Josh, would be the early retirement that we announced in Q4 of last year. That is largely going to start having major impacts on our business in Q2.

So what we did was go through each one of our operations and with this new volume that we are looking at make sure because we saw how favorable these decrementals look that we've got the actions either already completed and the savings started or that we are realizing benefits from programs that we put in place last year and the year before frankly in some economies that are going to be impacting the bottom line for Q2.

So we feel very good about the guidance that we gave there and we realize that the decrementals are something that are at first glance could appear to be aggressive.

Is that fair though, the earlier supposition that you guys are destocking internally to go along with what your customers are doing? So should we look at that performance as even kind of better versus the absorption headwind?

I think so. I think so. We are able to handle the absorption headwind with the reduced volume with the amount of restructuring that we have planned on doing and I can't emphasize enough the power of a simplification program where we are trying to make the Company a lot more efficient, a lot less reliant on indirect overhead that is really not adding value and really being able to push our margins in directions that we have never seen before in the history of the Company. And so yes, we are able to overcome the lack of the absorption overhang that we are going to see in Q2.

All right, thanks, guys.

Andrew Casey, Wells Fargo Securities.

Thanks a lot. Good morning, everybody. Wanted to ask a question on the revenue guidance. If I take your midpoint and the comment about the split 48% to first half, it kind of implies Q2 revenue down about 15% and I'm trying to square that with the comment about fiscal second half being down about 5%. So could you talk about the components of that Q2 forecast meaning organic and currency because I'm trying to understand the step up from 15% down to 5% down. Is that all currency or is there something else built into the outlook?

Andy, it is Tom. I will start and then Jon can fill in details if there is more follow-up that you have. But in the second half, that 5% I was talking about was total Company so that has the Industrial peace being down worse and that Aerospace being more positive. Currency is around -- for our midpoint, currency is about 2.7 points of the 9.5% for the full year and you are about right with what you thought for Q2. You have it around 14% down on sales.

Okay, thank you, Tom. And then one specific question, maybe Jon can help out. In the quarter on cash flow, there was about a $265 million consumption related to other assets and liabilities and that is the highest in a few quarters. Can you kind of detail what was in that?

In that case there was, we really only did three major things in the quarter. We bought stock and that is $310 million. We made a pension contribution of $200 million and we made acquisitions of $67 million for the quarter. So those are the major changes. There are some movements in the cash flow related to tax, the equity investment that we made in the Internet of Things company that Tom referred and a few other things Andy but that is really the lion's share of the uses of cash here for us in the quarter.

Okay, just to follow up on that, Jon, thank you. So the $200 million of pension funding, would that be within that $265 million?

Yes.

Okay. Thank you.

Joe Ritchie, Goldman Sachs.

Thank you. Good morning, everyone. So my first question, I guess just trying to get my head around the topline reduction was roughly about $1 billion in revenue and you guys kept the restructuring plans and simplification plans at roughly $100 million. How much of that is a question of internal capacity to actually do additional restructuring given what you have in place today as opposed to just feeling like the $100 million is the right number and aligned and you will be at the right place even in a lower growth environment?

Joe, this is Tom. I think what we are finding on the restructuring is a couple of things. One, we are able to do a lot of projects less expensive than what we anticipated so we are actually adding to the project list. We didn't change the number to you, we are adding extra projects because we have been more efficient on the ones that we have already looked at. Simplification in general is a more efficient way of deploying restructuring spend because it is not dealing as much with footprint consolidations, plant closures and all of that which carry typically more cost. It is more focused on SG&A, the overhead piece of things. And so when you do division consolidations, you look at optimizing organization structure, processes. When we did the early retirement, we look at organization design changes, did not have to replace people in kind at least not one for one.

All those changes can be done more efficiently but without the same level of restructuring. So we are actually doing more within that envelope of $100 million. We just didn't need to change the dollar amount because we are just being more efficient.

That is helpful. That is helpful color there, Tom. Maybe just asking a little more detailed question on one of the segments, you haven't really heard much about Aero yet orders deteriorated double digits now for the second quarter in a row. I am just curious what is going on there? How should we expect that to read through to growth, not just in this year but also into next year because it tends to be a little bit longer cycle?

Joe, Jon here. Just to give you first top-level answer to that, keep in mind that when we publish our Aerospace numbers they are trailing 12-month rolling forecasts and last year the comparables are tough for us for right now because last year we booked several multi-year, multi-program large orders and those large orders that we booked ran our 12-month number way up. We were up approximately this time last year, we were up 12 and so we are looking at that. We are down 16 now. It is not really nearly as severe as it appears.

We are still confident in our growth rates going forward in the 4% level in Aerospace. So I completely appreciate the question and how that looks very unusual. We have been taking a really hard, hard look at that and we feel confident that it was just that series of multi-program, multi-year orders that we booked based on contracts that we received that were fully priced and scheduled out that drove our orders up at that point in time.

Okay, great. I will get back in queue. Thanks, guys.

Nathan Jones, Stifel.

Good morning, everyone. A question on the guidance first. There is a $30 million reduction in corporate expense for the year, can you give us some more color around that?

Nathan, that is -- primarily the biggest driver there is as a result of the pension contribution that we did in August, our pension expense for underfunded plans is going down and that is the major driver.

Okay, that makes sense. And then on the free cash flow conversion dip down 90 basis points year-over-year, been hearing several companies talk about difficulty with collections primarily in emerging markets in this environment. Is there any impact there to you or what is the reason for that 90 basis point lower conversion?

If you are talking about -- we really have two things going on here in the quarter. We are looking at DSO very carefully. We are not seeing any degradation whatsoever but we are very aware of the issue and we are very focused on that. The issue for us was really in our inventories. We will see that correct in Q2 and Q3 and we will see better cash. We always perform much better in a cash -- from a cash environment and we have been able to prove that over the years as things start to slow down a little bit. So we are fully confident but I think it is mainly our performance in the inventory that is the outlier there that we will see correct as the year goes on.

Okay. And then you were talking about the sales price index not changing. I know you also track a cost price index. Are you seeing any more or less favorable outcomes there?

Yes, Nathan, this is Tom. Yes, we are working that hard. That is one of the initiatives that we have if you remember from our walk to 17% ROS on the operating margin side is working the supply chain. And yes, we are seeing improvements and we will continue to work that. We will work that on the indirect side which doesn't necessarily show up in our purchase price index but it shows up in lower expenses which is part of helping us on our margin returns. But yes, we are working that hard and when I look at SPI to PPI, it is neutral to slightly positive, that comparison.

Do you think you can hold that positive for the year?

I think so, yes.

All right. Thanks very much.

Andrew Obin, Bank of America Merrill Lynch.

Yes, good morning. Thanks for fitting me in. So a question, in terms of leverage versus lower earnings forecast, how should we think about your willingness to take on leverage in this notably weaker environment yet an environment that could down the road present M&A opportunities?

Andrew, this is Tom. I think as always we want to make the best long-term decision for our shareholders looking at acquisitions versus share repurchase. We still are committed to our A rating and so that is a function that we look at all the time so with we do our cash allocation discussion every quarter. We look at cash generated versus where we are in our debt to debt equity relationship and we make the best decisions that we possibly can on behalf of the shareholders. But certainly the A rating is a controlling device that we use. I think it has been helpful for us and the bulk of our peers if you look at, they are all A rated and we think that is an advantage for us to continue to do that.

And in your view I know that rating agencies are being company specific but what does it mean in terms of sort of the upper band of leverage you would be comfortable with?

We work, we typically work to a 37% debt to total cap.

Thanks.

Thank you, Andrew. This concludes our Q&A and our earnings call for today. Thank you so much for everybody joining us today. Robin will be available throughout the day to take your calls should you have any further questions. Thank you. Have a great day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a very good day.