派克漢尼汾 (PH) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Parker Hannifin Q4 2016 earnings conference call.

(Operator Instructions)

As a reminder today's conference call is being recorded. I would now like to turn the conference over to Mr. Jon Marten, Executive Vice President and CFO. Please go ahead sir.

Okay. Thank you, Candace, and again, good morning, everybody, and welcome to Parker-Hannifin's fourth quarter FY2016 earnings release teleconference. Joining me today is Chairman and 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 number 2, you will find the Company's Safe Harbor disclosure statement addressing forward-looking statements, as well as our non-GAAP financial measures. Reconciliations for any references to non-GAAP financial measures are included in this morning's press release and are posted on Parker's website at phstock.com.

Turning to today's agenda on slide number 3. To begin, our Chairman and Chief Executive Officer, Tom Williams will provide highlights for the fourth quarter and full FY16. Following Tom's comments, I will provide a review of the Company's fourth-quarter and full-year 2016 performance, together with the guidance for FY17. Tom will then provide a few summary comments and then we'll open the call for a Q&A session. At this time, I will turn it over to Tom and ask that you refer to slides number 4 and 5.

Thanks, Jon, and welcome to everyone on the call. We appreciate your participation this morning.

Today, I'd like to cover the following key topics: Our fourth-quarter results, review our FY17 guidance, and finally, I'll highlight the progress we're making with the new Win Strategy.

Let me start with the fourth-quarter and full-year results, which demonstrate the progress we're making in a difficult growth environment. Fourth-quarter sales were $2.96 billion or a 6% decline, compared with the same quarter a year ago. This represents the second consecutive quarter we saw sequential improvement in sales and a decelerating rate of decline in sales on a year-over-year basis. Total order rates for the fourth quarter declined 1%, compared with the same quarter last year, and represented a sequential improvement from the third-quarter level.

By segment, North America is still weak, but our aerospace systems segment and international business order rates were positive on a year-over-year basis. Net income for the fourth quarter increased 35% to $242 million on an as-reported basis, or a 29% increase, to $269 million on an adjusted basis. Earnings per share for the quarter were $1.77, as reported, or $1.90 on an adjusted basis. That represents a 33% increase, compared to the same quarter last year on an adjusted basis.

Despite ongoing weakness in our end markets this quarter, we were able to achieve total segment operating margins of 14.8%, or 15.6% adjusted. This is tremendous performance and represents a 70 basis-point improvement year over year in adjusted segment operating margins. Our adjusted decremental MROS was 2.9% for the fourth quarter. This is the sixth consecutive quarter that our adjusted decrementals have been below 25%, which is the best level performance I can remember in any previous downturn.

Just a few other full-year highlights that I would like to note. Cash flow was strong in the quarter and also the year, with cash flow from operations, excluding the discretionary pension contribution, exceeding 12% of sales, reflecting the stability of our cash generation during a downturn. We also held inventory as a percent of sales essentially flat at 10.3% in FY16, versus 10.2% in the prior year. We executed very efficiently on the $109 million worth of business realignment, even including this restructuring, our as-reported decremental MROS was 19.5% for the full year. And, notably, we accomplished all this while sales dropped $1.35 billion, which is very difficult to do.

Moving on to capital allocation. During the fourth quarter we repurchased $108 million in Parker shares, bringing our total share repurchases for the fiscal year to $558 million. We have now purchased $1.9 billion of Parker shares since our share repurchase plan was announced in October 2014. We're on track to meet our commitments on capital deployment.

Regarding FY17 guidance, we are forecasting a year of sales being flat, compared with FY16. Our expectations that organic growth will be soft in the first quarter, becoming essentially flat in quarter two, with the second half showing 1% to 2% organic growth on a year-over-year basis. For FY17, we're issuing guidance for as-reported earnings in the range of $6.15 to $6.95 per share or $6.50 at the mid-point. On an adjusted basis we expect earnings per share in the range of $6.40 to $7.10 for a midpoint of $6.75. Business realignment expenses are anticipated to be approximately $48 million or $0.25 per share.

So, now just a few comments about our progress with the Win Strategy. We continue to make meaningful progress with initiatives across four broad goals: Engage people, premier customer experience, profitable growth and financial performance.

Regarding our first goal to engage people. During this past year we saw a 33% reduction in recordable injuries. We continue to target a zero-accident safety goal, not only because it's our responsibility to our team members, but also because improved safety performance can be a leading indicator of improved financial performance. Our high performance teams are driving this improvement in safety, as well as quality, cost and delivery.

Now, in the second goal, premier customer experience, on July 1 of this year, we launched our likely-to-recommend initiative, which is designed to get direct feedback from customers and distributors on areas where we can improve. Importantly, we are gathering this feedback in a way that every site of Parker can understand and track their performance and make improvements. This is a significant initiative because a better customer experience will drive fast, organic growth for Parker.

We are also making good progress in building our e-business capabilities that will deliver a best-in-class online experience for customers and we're making progress developing our pipeline of Internet of Things applications across groups and product lines to enhance the value we bring to customers.

Now, moving to the third goal, profitable growth. We continue to drive innovative products and systems, expand distribution and build our service business as part of our sales-growth strategy. Acquisitions will play a role in our growth plans. We recently closed a transaction in Europe to acquire certain businesses of the Jager Group to strengthen our position in worldwide ceiling markets, as part of our Engineering Materials Group.

And lastly, our financial performance goal. Profitability in aerospace is improving, as we benefit from lower non-reoccurring engineering costs that were associated with some of the large program wins that we had and improved operational efficiencies. Our simplification initiative is also gaining momentum across the Company, as we discover more ways to streamline operations and better serve our customers. The best way to illustrate this is to look at our employment trends.

The total number of Parker team members employed at the end of FY16 is at 2004 levels, or, approximately 48,000 people. In FY04, our reported sales were $6.9 billion, whereas, today, our sales are $11.3 billion, with the same number of team members. This is a tribute to our global team members who are working together to find better and more efficient ways to accomplish their jobs and serve our customers. The combination of our simplification and lean-enterprise initiatives is amplifying our ability to improve processes and make significant structural cost improvements. In addition, our strategic supply-chain and value-pricing initiatives give us sufficient horsepower to propel us to our profit-margin goals in the future.

So, in summary, by executing the new Win Strategy, we're confident we will achieve our key financial objectives by the end of FY20 and this includes targeting sales growth of 150 basis points higher than the rate of global industrial production. We are also targeting 17% segment operating margins and progress towards these goals is expected to drive a compound annual growth rate in earnings per share of 8% over this five-year period.

I'm very pleased at how far we have come in such a short period of time and continue to be excited about the opportunities we have for the future, as we strive to make Parker a top-quartile-performing Company, as compared to our proxy peers. So, for now, I'm going to hand things back to Jon; let him give you more details on the quarter, the full year and 2017 guidance.

Thanks, Tom. And, at this time, please refer to slide number 6. I'll begin by addressing earnings per share for the quarter.

Adjusted earnings per share for the quarter were $1.90 versus $1.43 for the same quarter a year ago. This equates to an increase of $0.47. This excludes business realignment expenses of $0.13, which compares to $0.16 for the same quarter last year. Adjusted earnings per share for the full-year 2016, were $6.46, versus $7.25 for the full-year 2015. Total realignment expenses and pension termination costs were $0.57 for the full-year 2016 and that compares to adjustments for business realignment and voluntary retirement expenses of $0.28 for the full-year 2015.

On slide number 7, you'll find that significant components of the walk from adjusted earnings per share of $1.43 for the fourth-quarter 2015 to $1.90 for the fourth quarter of this year. Increases to adjusted per-share income include a reduction of corporate G&A, interest and other expense, equating to $0.14 per share, which is a result of savings realized from FY16 simplification efforts, as Tom just mentioned, one-time credits booked in Q4 FY16 and the comparison to a higher expense in Q4 2015 from early retirement expenses incurred and a lower effective tax rate in FY16 of 28%, versus 40.9% in Q4 of 2015. This all contributed to $0.30 per share.

The impact of fewer shares outstanding, due to the Company's share repurchase activity, equated to an increase of $0.05 per share. A reduction of $0.02 in adjusted per-share income was a result of lower adjusted segment operating income, which was driven by the strength in US dollar currency translation and weakened end markets, which approximates a little bit more than $200 million quarter to quarter.

On slide number 8, you'll find the significant component of the walk from adjusted earnings per share of $7.25 for the full-year 2015 to $6.46 for the full-year 2016. For the full-year 2016, increases to adjusted earnings per share include reduced corporate G&A expense, equating to $0.20 per share, $0.13 per share due to a lower effective tax rate of 27.6% in FY16, versus 29.3% in FY15, which is due to favorable discrete benefits booked during FY16 and $0.36 from fewer shares outstanding, reflecting the full-year impact of Parker's enhanced share-repurchase program. Decreases to adjusted earnings per share for FY16 were lowered segment-operating income of $1.00 per share, due to the impact of the weakened end markets and higher interest and other expense, equating to $0.48 per share, which compares to a sizable one-time favorable currency adjustment recognized in FY15 and a full-year impact of interest expense on incremental debt issued in November of 2014.

Moving to slide number 9, with a review of the total Company sales and segment-operating margins for the fourth quarter and full year, total Company organic sales in the fourth quarter decreased by 5.3% over the same quarter last year. There was minimal contribution to sales in the quarter from acquisitions. Currency impact as a percentage of sales was slightly higher than our guide, equating to a negative impact on reported sales of $31 million, or 1% in the quarter.

Total segment operating margin for the fourth quarter adjustment for realignment costs incurred in the quarter was 15.6% versus 14.9% for the same quarter last year. Business realignment costs incurred in the quarter were $25 million versus $27 million last year. The lower-adjusted, segment-operating income this quarter of $462 million, versus $468 million last year, reflects the meaningful impact of the weakened industrial end markets, partially offset by the savings realized from our very large simplification and restructuring actions taken throughout the year. For the full-year, organic sales in FY17 decreased by 7.7%. Contributions to sales from acquisitions were minimal.

The effect of foreign-currency translation resulted in a negative impact to reported sales of $404 million, or 3.2% of sales for the full year. Total Company segment-operating margin for FY16, adjusted for realignment costs incurred during the year, was 14.8% versus 14.9% in FY15. Business run realignment expenses incurred in FY16, was $107 million.

Slide number 10 discusses the business segments and I will start, first, with the diversified industrial North America segment. For the fourth quarter, North American organic sales decreased by 10.3%, as compared to the same quarter last year. There was a nominal impact from acquisition, but a negative impact from currency of 0.6% in the quarter. Operating margin for the fourth quarter adjusted for realignment costs was 18% of sales, versus 17.3% in the prior year.

Business realignment expenses incurred totaled $5 million, as compared to $15 million in the same prior year. Adjusted operating income was $226 million, as compared to $244 million, which is driven by the reduced volume, as a result of the key industrial weak markets.

For the full-year, organic sales for the FY16 decreased by 12.4%. Contributions to sales from acquisitions were minimal. The impact of foreign currency translation resulted in a negative impact of reported sales of $60 million, or 1% of sales for the full year.

For the full-year 2016, operating margin, adjusted for realignment cost, was 16.8% of sales, versus 17% in the prior year. Business-realignment expenses incurred totaled $42 million, as compared to $16 million in FY15. Adjusted operating income for FY16 was $832 million, as compared to $972 million in the prior year.

Now turning to slide number 11, I will continue with the diversified industrial segments. Organic sales for the diversified industrial international segment, organic sales for the fourth quarter in the segment decreased by 3%. Currency translation negatively impacted sales by 2%.

Operating margin for the fourth-quarter, adjusted for business realignment cost, was 12.6% of sales versus 10.9% in the prior year. Realignment expenses incurred in the quarter totaled $18 million, as compared to $6 million in the prior year.

Adjusted operating income was $137 million, as compared to $124 million, which, despite the weakened top line, reflects the offsetting savings, resulting from realignment actions taken in the current year, as well as the prior fiscal years.

For the full year, organic sales for FY16 decreased by 6%. The impact of foreign currency translation resulted in a negative impact to reported sales of $339 million or a negative 7.1% of sales for the year.

For the full-year 2016, operating margin, adjusted for realignment cost, was 12.3% of sales, versus 12.9% in the prior year. Restructuring expenses totaled $61 million, as compared to $27 million in FY15. Adjusted operating income for FY16 was $509 million, as compared to $611 million last year.

And I'll now move to slide number 12 to review the aerospace systems segment. Organic revenues increased 2.2% for the quarter. Neither acquisitions nor currency really impacted revenues. Strong growth in military OEM and military aftermarket sales were the drivers for the quarterly performance.

Operating margin for the fourth-quarter, adjusted for realignment cost, was 16.4% of sales, versus 16.9% in the prior year. Business realignment expenses incurred in the quarter totaled $1 million as compared to $6 million in the prior year.

Adjusted operating income was flat, at $99 million, for both Q4 2016 and the prior year, reflecting the impact of the reduced commercial sales volume in the quarter, albeit partially offset by reduced development costs as a percentage of sales.

For the full year, organic sales for FY16 increased by 0.5% of sales. For the full-year 2016, operating margin, adjusted for realignment cost, was 15.1% of sales, versus 13.5% in the prior year.

Business realignment expenses incurred totaled $4 million as compared to $6 million related in the prior year and adjusted operating income for the fiscal year was $341 million, as compared to $305 million last year, which was largely attributed to the reduction of development cost to slightly less than 8% of sales, together with the savings from business realignment activities.

Going to slide number 13, moving to that slide is a detail about orders changes by segment. As a reminder, our orders represent a trailing average and are reported as a percentage increase of absolute dollars, year over year, excluding acquisitions, divestitures and currency that diversified industrial segments report on a three-month rolling average, while aerospace systems are based on a 12-month rolling average.

Total orders improved to a negative 1% for the quarter-end reflecting a decelerating rate of decline in key industrial end markets, including oil and gas, construction and agriculture. Diversified industrial North America orders decreased to a negative 10%. Diversified industrial international orders improved to 3% for the quarter. Aerospace system orders increased to 14% for the quarter.

Looking at slide number 14, we report the cash flow from operations. For the fourth quarter, cash from operating activities was very strong at $488 million sales. This compares to 16.2% of sales for the same period last year.

For the full year, cash flow from operating activities for FY16 was $1.170 billion, or 10.3% of sales, as compared to 10.2% last year. When adjusted for the $200 million voluntary pension contribution made during the year, adjusted cash flow from operating activities was $1.370 billion, or 12.1% of sales, as compared to 10.2% in FY15. There was no pension contribution made during FY15.

The significant uses of cash during the year included $158 million for the Company's repurchase of common shares and $342 million for the payment of shareholders dividends. And there was $149 million for CapEx, equating to 1.3% of sales for FY16.

Now, turning to guidance for FY17, full-year earnings guidance for FY17 is outlined here. Guidance is provided on an adjusted basis. Segment operating margins and earnings per share exclude expected business realignment charges of $48 million, which are forecasted to be incurred throughout FY17. Total sales are expected to be in the range of negative-1.5% to 2.1%, as compared to the prior year. Adjusted organic growth at the mid-point is flat.

Currency in the guidance is not forecasted to impact sales. We have calculated the impact of currency to spot rates as of June 30, 2016 and we hold those rates steady as we estimate the resulting year-over-year impact for the upcoming FY17.

Total Parker adjusted segment operating margins forecast to be between 15.2% to 15.6%. This compares to 14.8% for FY16 on an adjusted basis.

The guidance for below-the-line items, which includes corporate G&A, interest and other expense, is $469 million for the year at the mid-point. Full-year tax rate is projected at 29%.

The average number of fully-diluted shares outstanding used in the full-year guidance is 135.5 million. For the full year guidance on and adjusted earnings per share is $6.40 to $7.10 or $6.75 at the mid-point. This guidance excludes business realignment expenses of approximately $48 million to be included in FY17. This is the only adjustments that we make to our guidance. It's just realignment expenses.

The effect of this restructuring on EPS is approximately $0.25 savings from these business realignment initiatives are projected to be $30 million and are fully reflected in the adjusted operating margin guidance range.

Some additional key assumptions for the fiscal year guidance are, sales are divided 48% first half, 52% second half, which is a normal distribution of a split for a year for us. Adjusted segment operating income is divided 46% in the first half, 54% in the second half. EPS in the first half, versus the second half, is $2.93 and $3.82 for the second half.

Q1 FY17 adjusted earnings per share is projected to be $1.52 at the midpoint and this excludes $0.09 of business realignment expenses.

On slide number 16, just some influences on EPS for 2017 as compared to 2016. On slide 16, you will find a reconciliation of the major components of FY17 adjusted EPS guidance of $6.75 per share at the mid-point from the prior FY16 EPS of $6.46 per share. Increases include $0.40 from an increased segment operating income and $0.11 from fewer shares outstanding and reduced interest expense.

Key components of the decrease include a $0.13 per-share reduction from taxes, reflecting a rate from continuing operations of 29%, and $0.09 per-share reduction from increased corporate G&A and other expense, as a result of normalized levels, not including one-time favorable settlements realized in the prior year, primarily in Q4, in part by reduced pension expense, due to the Company's adoption of the spot rate methodology for calculating annual expense. This has a total impact of $0.11 for FY17.

Please remember that the forecast excludes any acquisition and divestitures that might close during FY17. For consistency, we ask that you exclude only the restructuring expenses from your published estimates. This concludes my prepared remarks. Tom, I will turn the call back over to you for your summary comments.

Thanks, Jon. We are very proud of the FY16 results and I'd like to thank Parker team members around the world for their efforts. These accomplishments carry even greater significance given the $1.35 billion drop in sales that occurred during the year. While we still have much more to achieve, we are positioned well for FY17 and beyond, under the framework provided by the Win Strategy. Together we are building a stronger and better Parker. I look forward to sharing more with you as the year progresses.

At this time, Candace, we are ready to take questions, if you want to go ahead and open the lines.

(Operator Instructions)

Jamie Cook, Credit Suisse.

Hi, good morning. I guess a couple questions on the guidance.

One of the things that struck me is, generally, when you guys guide for this fiscal year, you come in well below consensus and you are sort of at the mid-point, which struck me. So, any comment on that? But, specifically, I'm trying to get comfortable with -- can you give color on the orders in North America, which, I think, were down in the 10% range, which, I guess, surprised me.

I'm trying to bridge that with your sales guidance in North America, which seems more optimistic. And, then, at the same time, on a down sales, year over year, you are expecting margin improvement on an adjusted basis? So, if you could address those issues, I'd appreciate it. Thank you.

Okay, Jamie, it's Tom. The topics were interwoven, so I will start with the guide, what was behind it. And I'll start with, in case those of you that were on the phone didn't hear my opening comments. This is going to be a year of sales leveling off, which, after the sharp reduction that we had last year, is going to be a very refreshing change for all of our people around the world.

But, the way we forecasted this is Q1 is going to be soft, moving to essentially flat in Q2, with 1% to 2% sales growth in the second half. So, our thoughts behind the numbers; The natural resource-related end markets -- so, construction, ag, mining and oil and gas, are moderating and they are going to continue to be, year over year, when we finish 2017 negative; but they're going to get to be less and less of a drag, especially in the second half.

When you look at order entry that we had in Q4, in particular, what drove our thoughts with international is that we had a positive international, plus 3%, and that was made up of Europe being basically flat, minus 1% in that area, Asia plus 6% and Latin America plus 19%. So, what's really driving our international sales forecast is a forecast of Europe being relatively flat and Asia Pacific and Latin America being up a little bit, driving an international forecast of plus 2%.

You talked about North America, what we saw in Q4, I would characterize as continued choppiness around what we saw from Q3 to Q4. During the quarter, April started off a little bit softer than we would have liked and then May and June were a little bit better.

What we are seeing for North America for the full year, to give you some context as to the negative 3% that we have out there, is that we have a first half of minus 5% and a second half of minus 1%. And what's driving that is, if you look at the natural resource related end markets that I described, they really bottomed in North America in our second half of the year.

We are not really anticipating any new activity that's going to drive growth or sustainability beyond our current levels for natural resources, but what you're seeing in North America is easier comps in the second half. We do have growth in North America in non-natural resource-related markets, like machine tools, telecom, life sciences, turf, refrigeration, that is going to now help to offset some of that; not completely, because we'll still end North America at a minus 3%.

If I could, I'm going to give you context, our view for the total end markets for the whole FY17 and I want to put an asterisk by this. I'm not trying to describe the entire end market; I'm just trying to describe our performance in that end market, so I have them in three buckets: positive, neutral and negative.

So, on the positive side, what makes up our forecast is aerospace, on a turf, passenger rail, refrigeration and air-conditioning, semi-con, and telecom. In the neutral areas, automotive, distribution and life sciences and power generation.

Now, of significance is, is the distribution in neutral, while that's not in end markets, it's a big channel for us, and the fact that distribution moves to neutral helps the year stabilize quite a bit.

And then under negative, is construction, farm and ag, forestry, general industrial, heavy-duty truck, marine, mining and oil and gas. That's the landscape and I probably gave you more than you wanted to know. That's what we think for 2017.

That's helpful on the top line. Sorry, just to clarify, though, because I'm trying to understand the margin story. If you could tell me the incremental savings from restructuring actions taken in 2016 that help 2017 and then, the $48 million of charges in 2017, how much of that do we realize?

You know, the $48 million in cost, how much is that to be realized in savings and I'm assuming most of that is in North America? And then I'll get back in queue. Thanks.

Jamie, John here. Just for the restructuring in FY17, of the $48 million, we're expecting $30 million in savings in FY17. And, the restructuring savings that would have been incurred, based on FY16 actions, rolling into FY17, is about $25 million. That is obviously helping our margins going forward and it's a big driver to our future health, as Tom outlined earlier, so those are the details there.

They are about half North America, half international and one other way to describe them is that they are about one half simplification efforts and one half restructuring, traditional restructuring, which would include some planned closures.

Okay. Thank you. I will get back in queue. I appreciate the color.

Josh Pokrzywinski, Buckingham Research.

Hi, good morning, guys.

Hi Josh.

Just maybe to follow up on Jamie's question a little bit. Can you talk about some of the mix dynamics that you are seeing in North America, that could maybe support a bit of a margin lift here? Maybe extra structuring; how should we think about the underlying incrementals and decrementals and the progression through the year? Maybe what you saw in the fourth quarter that gives you the confidence in that launch pad?

If I take Q4 sequentially, I was talking about there's really kind of two things that we saw. The natural resource-related end markets - Josh this is Tom, by the way, sorry. We still saw those in that minus 10% to minus 15% range, mining, oil and gas, ag, in the distribution that had exposure to that.

But, what gives us confidence is, when you look at the non-natural resource-related end markets in Q4, those fell anywhere from flat to a plus 15%, so distribution being up mid-single digits, which is a big part of North America, machine tools, telecom, life sciences, turf. Refrigeration has been very -- and air conditioning has been very strong for us, and automotive, about flat, slightly positive.

So, that was really the mix that felt this good about the North America forecast. The other part is that we do know the natural resource comps in those particular end markets gets much easier in the second half, which is why our first quarter for North America, we are not anticipating anything much differently than what we saw in the current quarter; maybe a hair better, because the comps gets easier in the second half is why we forecasted a better comp in the second half.

Is it fair to say that of the -- and, I'm sorry, Jon, I missed all the numbers you gave for restructuring plus carryover restructuring. It sounded like something around $40 million to $45 million. If I take those and, maybe the gap in your guidance is another $30 million or so, to get to the mid-point for segment op margin or segment op income, fair to say that the other $30 million is mix?

I guess, there's really not a lot of revenue growth; presumably price cost isn't an inordinate benefit this fiscal year. Just trying to bridge that extra little piece to get to the mid-point.

Josh, altogether, I think you've got it. It's going to be mix; it's going to be further productivity that we are going to realize. It's going to be lean. It's going to be the normal Parker operating protocols that we use.

And we are expecting, without regard to the realignment that we did in FY16, and we plan to do in FY17, to become even more productive in FY17. And, so, yes, that's how we bridge that gap internally here.

Okay. So, there's not a scenario, though, where, on an underlying-volume basis, when things are still tough, decrementals kind of X all the productivity in lean and restructuring are very low. And, then, you still expect them to accelerate. Sounds like volume is neutral-ish, but there's just a lot of heavy lifting that's going on behind the scenes doing most of that op improvement?

Yes. I would say that's correct. The volume being flat, as Tom described, and North America maybe getting a little bit better, as the year goes on in FY17, is going to help us from a marginal standpoint. In North America and internationally, we are seeing good productivity gains that we have made from the restructurings we have done in FY16 and, really, frankly, for FY15, also.

So, we feel like we are very well positioned from a cost-structure standpoint and we're poised with any tailwinds at all, at the high level, to really be able to generate some impressive incremental margins, once the volume turns around.

Thanks for the color, guys. I will get back in queue.

Nathan Jones, Stifel.

Good morning everyone.

Hey, Nathan.

I think, Jon, you're talking a little bit here about volume and natural resource markets being essentially flat and the comps get easier as the year goes on. I think we kind of entered last year with a similar expectation of some improvement in the back half of the year, which, obviously, didn't materialize. Can you talk about the differences between what you're seeing in the market now, versus 12 months ago, that gives you that confidence that you are going to see potential uptick in the second half?

Nathan, this is Tom. I think the confidence would be, if you just took oil and gas as an example, nobody could have anticipated going back 12 months ago, the rig-count reduction that happened. But, now that rig counts have stabilized in the last several weeks, minus maybe a week or two, have actually improved, are not forecasting them to get any better, but, just by the comps, and the fact they have decelerated or are starting to hold that level, it makes our second half, naturally, a little bit better.

We're still not -- I don't think we're out on a limb with North America at a minus 1% in the second half, given we normally have a second half a little bit better and the fact that I think we've seen the worst behind us in the natural resource areas and those non-natural resource areas I mentioned, starting to show some growth for us.

I think that's why we picked what we did and at this point we are as confident as we can be. Of course every quarter we will update you as that changes.

Thanks. Is it possible for you to parse out what you think the impacts might be on North American orders from the natural resource markets? You had a nice plus 3% in international and still minus 10% in North America. How much do you think natural resource markets are impacting that in North America, versus international?

Nathan, this is Tom again. It's hard to do on in order basis. I will give you what we saw sequentially on sales. It was what I was mentioning earlier. We saw natural resources in that minus 10% to minus 15% range, including the distribution related to natural resources. And, then, the non-natural resources were all 0% to plus 15%. Refrigeration and air-conditioning would be the strongest, given this time of year.

So that's the mix. The natural resource areas, again, that's about where we have been, give or take a little bit. As we look to the second half of the year, those comps just get easier for us and that becomes less of a drag and the positive end market start to get us to the minus 1%, second half, that we forecasted.

Okay and just one on how to think about the incremental margins. Tom, you mentioned in your prepared comments that you have had historically low decrementals during this down cycle, which is obviously a tribute to the business. Does that also change the profile of the incremental margins that we should be thinking about when volume returns? Is the cost structure structurally changed to the point where you would expect higher incremental margins on volume as volume comes back?

Nathan, this is Tom. I think we would. Historically, when we have come out of a downturn, we would be maybe a plus 40% and, then, start every quarter that went from the initial uptick, we start to glide down to a plus 30%, and, then, as you get deeper into a growth segment here in the 20%s, eventually, probably, bottoming out in the upper teens.

I think what we have done, structurally, and the fact we are simpler, leaner, and have a much better cost structure, we would never have been able to put up the MROS that we put up without doing the actions we have taken.

And, it's worth repeating again. The all-in reported MROS, 19.5%, so that's all the restructuring, $109 million, which is the highest restructuring we've done in the history of the Company. Even with that we put up 19.5% MROS.

So, yes, I think it can be higher. Could I pick a number? No, that would be difficult to do, but, I would expect it to be higher than what we've done historically

Thanks very much for the help.

Joe Ritchie, Goldman Sachs.

Thanks. Good morning everyone and nice job on the cost control this quarter.

Thanks Joe.

My first question is really around distribution, so, Tom, your comments that distribution is going to be neutral, your counter expectation is neutral in 2017. Can you give us some thoughts there?

Clearly, as we ended the quarter, the data points we got from the industrial markets were pretty weak. We got a slightly more positive data point today from Fastenal and, so, maybe just comment on what you are seeing in distribution that gives you confidence that it actually can be neutral in 2017.

Joe, this is Tom. I will start off and I would like Lee to just tag team.

The confidence here is that, when we look at how the quarter came out, sequentially, distribution was basically flat and those non-natural resource-related areas that we have talked about in the past and the various reasons are growing mid-single digits and we have a really on-purpose program to add distribution, especially in the emerging areas, in Asia, in Eastern Europe, Africa, Latin America, and our teams are working very hard at that.

When we look at the emerging markets, they are showing some positive growth in distribution. I think that combination of all of those gives us confidence that we can come in at a neutral for distribution. I don't know if Lee has anything else to add?

No, Joe, I would say, commenting on North America, I spent quite a bit of time with these guys, there's just no doubt that there's still a big hangover from the natural resource markets, oil and gas being a big one.

But, if we'd seen that, you do get this impression that things are flattening out. We do see some signs of MRO spend taking place and it's really a lack of cannibalization of idle rigs that are out there, so, we see activity there.

And, I think there is this general encouragement through the channel that, with continued strength in the automotive end markets and continued positive PMI data, that they are cautiously optimistic that there is some positive signs going forward.

Was it your sense that, from an inventory standpoint, we have now gotten to levels that we need to be, in order for your growth rates to reflect end-market demand?

I would say, in general, that the whole de-stocking question, I don't see big evidence of that in place. That's not to say there may not be a pocket here or there, but, in general, I would say inventories are in line with the current activity.

Okay. And maybe one follow-up question for Jon. Can you talk a little bit about your cash bridge next year? Specifically, I'm interested in your pension funded status, whether there's going to be an additional contribution in 2017 and any other puts and takes you could talk about from a cash flow perspective for next year? Thank you.

Yes, Joe. I think, first, on the pension contribution, that is possible. I don't want to say we are doing it or we're not. We're going to have to look at that very hard, but that is possible.

If we do it, it would be in the normal range. We've done over the last several years, other than an FY15, which we didn't do anything. I think that from a capital standpoint here, from a CapEx, we would be about 2% of sales. Those are the kind of the big drivers here for us.

Our pension expense for next year, as I tried to mention in my comments, was going to be impacted positively, in total, altogether, by $0.11, impacting FY17, due to the spot rate methodology that we have adopted, as well as many other puts and takes that go into making those estimates and doing the accounting for that.

So, the CapEx of 2%, we never forecast acquisitions, of course. From a pension expense standpoint, it's quite possible that we would have a normal contribution there. That's about what I can give you right now. Is there any more color you would want at this point?

I guess just what the funded status of your pension is today and whether you expect working capital to be positive or negative next year?

I think working capital is going to be positive. Now, we're going to show sales growth in Q4, so, that will be a slight drag, but we are making tremendous progress on our cost controls, as well as our inventory management.

Our inventories, with this kind of a decline in sales, are at a historic low, as to percent of sales. We expect our ability to manage through inventories, to more than offset the drag that we might have from the AR, as our Q4 shows a little bit better.

Our funded status, right now, for our pension plan is at 65%, which is a little bit lower than we would want it to be, and that's pure assets to liabilities. Of course, regulatorily, we are well over 100% required, but, there would be an argument to make, that from a voluntary contribution standpoint, that it would make sense, given our assets- and liability-funded status at 65% right now.

Okay, thank you, guys.

David Raso, Evercore.

Hi, a quick clarification, first, before my question. The savings, the carryover, plus the incremental from this year, what is the exact number again?

The savings carryover into FY17, $25 million. The savings related to the FY17 restructuring, $30 million.

Okay. So, basically, the segment profit for the year, total Company's guided up about $72 million. $55 million from savings and $21 million from pension. Is that essentially --

Those are the numbers. I hate to draw a straight line between the restructuring and the savings and our increased guidance because there is a lot of other factors that go in, as you well know, Dave, that go into that. But, that would be one way to look at it.

That's a generic, flat revenues, keep profit flat, ideally, on it, at 20% plus for pension and 55 for save and that's the generic framework. My question was the international growth, the cadence.

Can you walk us through - and if you said it earlier, I apologize. I know you said up for North America, but I might've missed it internationally. The up 3% for the year, 3.2%, to be exact, how do we get there from the down 3% we are exiting the year. Comps get easier, orders were up, but if you can help us with the cadence?

David, it is Tom. International, up 3%. 1 point of that is acquisitions. That's the Jager acquisition for the year. So, it's two points of growth for international and our forecast is that's Europe at flat, Asia plus 4% and Latin America plus 15%, and, I recognize Latin America is a small number and it's bouncing off a very sharp decline.

And, what's supporting that is the orders that we saw in Q4 and it's continued in July, is the international orders, we saw Europe around flat. We've seen Asia orders plus 6% and Latin American orders plus 19%. We see some opportunities in Asia and Latin America, in particular, and we see Europe is neutral. That's what's making up the plus 2% for international.

And the cadence of that, then? Could we be positive by fiscal 2Q? How quickly do we get positive to get the full year to 2%?

At the end of the first half.

Terrific. Thank you very much.

Jeff Hammond, KeyBanc.

Good morning, guys.

Good morning, Jeff.

You mentioned capital allocation; you'd be kind of within your range of targets for buyback and, with six months to go from completing that, can you just update us, as we look past that, how you may be thinking about capital allocation, the same or different, or do we get some formal multi-year announcement? Just flush that out and while you are at it, touch on acquisition pipeline?

Okay, Jeff, this is Tom. Let me start with just a clarification. We only have one more quarter left in the share repurchase plan; it was October to October 2014 to 2016. So, we will come in at the $2 billion level of that range that we said. And what's really kind of -- the factors we consider with that is that 99% of our cash is permanently invested overseas. We do have a desire to maintain that A rating and our debt to total cap is around almost 40%.

And, when we started the program, we were a $13 billion company; now we are $11.4 billion. We are very proud of the double-digit cash flow we have been able to generate, but, it's double digits off a smaller number. So that's what is framing where we come in at the low end of the range.

Going forward, our desire -- let me first state that we want to be great generators of cash and I think we've done a great job there. We're going to continue to do an even better job and we want to be known is a company that really spins up a lot of cash. On the flip side, we want to be known as a company that deploys it very effectively on behalf of shareholders.

You've heard me say this before, but for those, maybe if not, I'll repeat it. First and foremost, as far as our priorities, is to continue our dividend track record. Then, we're going to fund organic growth because it's the most efficient growth you can fund. And, then, really, it's a dynamic review on a case-by-case basis between share repurchase and acquisitions and, really, with the goal of generating the best long-term value for our shareholders.

On the share repurchase, you won't see us do another announcement type of process. I think what's better for shareholders is to be active, to have a muscular balance sheet, but to tell you after the fact, because when we announced in advance, we're buying into our own wind and I don't think that helps shareholders. I think we want to do it after the fact; that's the most effective way to use our cash and help shareholders.

Regarding acquisitions, the pipeline is active. But, I talked last quarter and the valuations continue to be, I would call it historically high, but I think time is on our side here, because we buy properties in spaces that we understand, so, we understand the growth rates.

I think sellers' expectations on growth rates is going to start to temper, as they recognize that the growth rates they think your business is going to do is not going to actually come to fruition. And I think you will see our pipeline become more actionable.

We've always been disciplined buyers and we will always continue to buy properties we know we can deliver on for our shareholders. So, we will look at all of that and, again, the goal is to have a muscular balance sheet and do what's best for our shareholders.

And just as a follow on, on international. Can you speak to what is inflecting in Asia to drive that plus 6% and, then, conversely, in Europe, any near-term signals of deterioration around Brexit?

Jeff, I will start on Asia and I will let Jon make comments on Brexit.

What we saw in Asia, we actually had positive sales in Asia for June and with the positive order entry that we had in Q4 and will continue into July, we saw positives in life sciences - I'm speaking about Asia, in general -- passenger rail, powergen, machine tools, and probably of significance because, for many years, we've been talking about this, we started to see some signs of life in mobile construction, in particular, India and Japan. But the good thing is, China is finally flattened out and we actually saw some new incremental orders in China.

We have all the countries across Asia growing, with the exception of Korea, and Korea just has a little more exposure to some of those global OEMs, so that will start to recover as well. That's what's behind our thoughts on Asia and I will let Jon talk about Brexit.

Just a quick comment on the Brexit impact, Jeff. We're in a position where we manufacture and ship out of the UK more than we buy into the UK and, so, since we export more than we import, we don't see that really having an impact on our near-term financials. Now, to the extent that the Brexit impact, long term, starts to impact the economics there, we will be watching that very closely. But the UK, overall, in terms of our sales there, will not meaningfully drive our top-line numbers, in any event.

Thanks a lot, guys.

Okay, Jeff.

Stephen Volkmann, Jefferies.

Hi, good morning, guys, for two more minutes. Can I just follow up? I think, Tom, you made some initial comments about simplification plans and I'm curious if there is more to come in that area, in terms of things like SKU reduction or business unit consolidation or, maybe even have some more divestitures. I know you've done a couple of small ones here and there, but can you just talk a little bit about what that's going to look like over the next couple of years?

Steve, this is Tom. I think there's great momentum for us across the Company on simplification and I mentioned in my opening comments, the combination of putting simplification with our lean enterprise efforts is giving us an amplification of being able to look at costs and process differently than we have in the past.

As I have mentioned before, and I will give you some comments as to where I think we can go on these, there are four big areas we focus on. The first is that whole revenue complexity, or, maybe another way of saying it is that product-line simplification, that tail of revenue, the last couple percent of revenue. We're in very early days on that.

That is probably our biggest opportunity going forward and that will be a multi-year journey, as we continue to find more efficient ways to service that tail, take care of our customers that work on the SG&A, the speed at which we can handle those type of orders, speed at which we can service customers, a lot of organization design activity will happen related to that. So, that will be a net win for our customers, as well as us.

But, very early days on that. That's the harder part because there are thousands and thousands of [departments] to go through. That's a more complicated part of it. We've done a lot of work, organizationally, and process-wise, that's the second bullet and I still see lots of opportunities there. I think you will see a focus on number of levels within the Company span the controls, putting together an organizational design that is the most effective design for our customers and for our people.

On the division consolidations, I think we've taken a pretty big step already on that piece. We had 28 divisions, so, basically, a quarter of all of our divisions going through some kind of consolidation, down to 14, so that dropped our total count of divisions from 115 to 101.

Lee is working with the presidents on that and we don't have anything to announce; because, in fairness to our people, we would not announce that in a public forum like this. But, we have already taken a big step there and you will see more fine tuning on that as we go.

And on bureaucracy, there's lots of opportunities within the Company. The whole annual plan process we redid was a huge upside for people, as far bring able to free up their time to do other things.

So, I would say we are very pleased with where we have come so far, but, there's a lot more to go on that and, if you have anything else, Steve, I'd be happy to answer any more.

Just some potential divestitures going forward?

We continue to look at the divestitures and we continue -- that's an ongoing basis, but, we like the portfolio as a whole. You look at our nine motion-control technology, if you look at the seven operating groups, 60% of our customers buy from four or more of those seven groups. So, our customer see the power of the systems we can do, the synergies we can do, across those technologies.

That being said, we still look at properties that we think potentially weren't strategic to us, or where we weren't the best corporate owner. We will continue to do that, but I would characterize that is very small, trimming-around-the-edges-type of divestitures.

Great I appreciate it. Thanks.

Candace, I see we are running up against it here. Can we take one last phone call here please?

Andy Casey, Wells Fargo Securities.

Thanks, good morning, everybody.

Hey, Andy.

Got a question on aerospace, one backward-looking and a little bit forward-looking. The first, can you give a little more color about the relative performance of commercial versus military, if you want to break it OE versus aftermarket, in the quarter. Also a little more color behind what drove the 50 basis-point margin decline versus last year?

Okay on the margin decline, basically, and last year, there were a few contractual settlements in the aerospace numbers. They did not repeat for this year. Of course, those are lumpy and can come sporadically. That's really the driver there, Andy.

From breaking those numbers down a little bit in terms of the sales, we are, basically, essentially flat in the commercial market. That's being impacted by the ability for us to be in a position where our BIS [jet] reduction is being overcome by our normal commercial increase. There has not been a significant change in the aftermarket there and it's been basically flat for us.

From a military standpoint, both OE and commercial, that has been up low double digits for us in the quarter. That would be reflected, not only in our sales, but in our orders. Again, all of these data that I give to you, it tends to be because it's such a long-term business; it tends to be very lumpy.

Our perfect world, we would be 50% commercial, 50% military. We are not now. We are 65% commercial and the balance, military right now. In a perfect world, we would be 50/50 OEM, versus aftermarket. We are at 66% OEM right now.

So, that would be indicative of further aftermarket revenues to come, as we are successful on, in our entry into service for all the commercial aircraft and as military ramps up over the next several years on some of the key programs that we are on. And, so, we have a lot of very high expectations for our performance and our growth there in aerospace and it's been a key to our successful FY16 and key to our guidance in FY17, too.

I hope that gives you some color there, Andy.

It does, Jon, thank you. I guess two more. I'm sorry to belabor it.

On aerospace, on the guidance, modest growth, kind of flattish to modest growth in margins [flat to] up 40 basis points. Is the margin growth or the potential expansion really mix-driven, or are there other factors that are driving that?

I think it's going to be efficiency. It's going to be the same adherence to all the programs that Tom has outlined before in our aerospace segment. And, it is going to be a natural mix of positive for us here into FY17.

Our growth on our new programs is going to be in the low-single digits and our growth in the repairs and aftermarket is going to be in the low single digits for FY17 and we also would expect to see our normal growth in our military aftermarket in FY17. So, there's no one segment of the aerospace that is driving the growth and there is no one answer for you on the margins. It's more mix and it's our ability to continue to be productive in aerospace on the margins, and it's an across-the-board increases in each one of the major segments there in FY17, too.

Okay, thanks and I'll follow up on that off-line.

On the diversified international, if I strip out, take kind of the 50/50 split on the savings, literally it looks like, if I strip that out, it looks like the core incrementals are somewhere around mid 20% range. Is that just application of what you would expect in your one of some sort of recovery after the downdraft we have seen? Or, is there upside opportunity, given the lean operations relative to the past?

I think that it is a reflection of our ability to implement lean. There is an uptick and, of course, the incremental returns we're going to get, because, as Tom and Lee have described, we're going to see an upturn in sequential revenues as the year goes on, especially in industrial international.

That is our best estimate right now and, so, we will see some marginal returns there. That 20% number seems, off the top of my head, reasonable, but I don't want to give you the impression that there is not also a lot of favorable disposition in our international industrial margins because of our ability to continue to penetrate markets, gain market share and grow in ways that are really quite favorable for the Company here and helping us with our guidance in 2017.

Okay. Thank you very much.

Okay. Thank you. I think this will be the balance of our call here today. I appreciate everybody's questions. I want to thank everybody for joining us.

Robin and Ryan will be available throughout the day to take your calls, should you have any further questions and I want to thank everybody again and wish everybody a good day.

Ladies and gentlemen thank you for participating in today's conference. That does conclude the program and you may all disconnect. Have a great day everyone.