派克漢尼汾 (PH) 2017 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Parker Hannifin Corporation's second-quarter 2017 Earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to turn the call over to Ms. Cathy Suever, Vice President, Corporate Controller and acting Chief Financial Officer. Ma'am, you may begin.

Thank you, Chelsea. Good morning and welcome to Parker Hannifin's second-quarter FY17 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 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 number 3. To begin, our Chairman and Chief Executive Officer, Tom Williams, will provide highlights for the second quarter of FY17. Following Tom's comments, I will provide a review of the Company second-quarter FY17 performance, together with the guidance for FY17. Tom will provide a few summary comments, and then will open the call for our question-and-answer session.

At this time, I will turn it over to Tom, and ask that you refer to slide number 4.

Thanks, Cathy, and welcome to everyone on the call. We appreciate your participation this morning. Today, I'd like to share highlights on our second-quarter results, a very strong quarter for Parker, give you an update on the CLARCOR transaction, and comment on changes to our FY17 guidance.

As I've shared before, keeping our people safe is our first priority, so I thought I once again report on that first. During the second quarter of 2017, we were able to reduce our recordable injuries by 31%, compared to the prior year. This builds upon a 33% year-over-year improvement we posted to compare in 2016 to 2015.

This improvement is being driven by a combination of strong leadership, training and the engagement of our team members globally through our high-performance team focus. Nationally, we have a long way to go to reach our goal of zero accidents, but I am very pleased at the progress we are making.

Now to the financial highlights of our second-quarter results. Overall, this is a very strong quarter for Parker. Second-quarter sales were $2.67 billion, a 1% decline compared with the same quarter a year ago.

Organic sales were basically flat, as the decline was primarily due to currency. This is largely in line with what we anticipated, and continues a favorable trend, with sales showing less of a decline quarter to quarter and top line growth expected to turn positive in the second half of our fiscal year. Order rates also continue to move in a positive direction for the second consecutive quarter. Total orders increased 5%, compared with the same quarter last year.

North America orders were flat. Industrial international orders were up 10% and in our Aerospace Systems segment, orders were up 9%. Net income for the second quarter was $241.4 million as reported, or $258.8 million adjusted, representing a 24% increase compared with adjusted net income in the second quarter of last year. Earnings per share were $1.78 as reported, or $1.91 on an adjusted basis, a 26% increase in adjusted earnings per share, compared with the same quarter last year.

During the quarter, we did record a pretax gain of $45 million or $0.21 per share related to the sale of our Autoline product line. Autoline manufactures quick connectors for passenger car applications, and was no longer a strategic fit within our portfolio. I am particularly pleased with our overall segment operating margin performance this quarter, which was the second quarter record at 14.4% as reported, or 14.7% on an adjusted basis.

Adjusted segment operating margins increased to 120 basis points, compared with the second quarter of FY16, which is an excellent year-over-year improvement. This is strong margin performance for Parker, and reflects the benefits of our implementation of the new Win Strategy. Year-to-date cash flow from operations, excluding a discretionary pension contribution was 11.5% of sales, reflecting our ability to be a consistent generator of cash through economic cycles.

Now, just a few comments on capital allocation. As previously disclosed, clearance has been received with respect to the regulatory filings made on the pending CLARCOR transaction. These events satisfied important conditions to the closing of the CLARCOR transaction. The transaction remains subject to other closing conditions, including approval by the CLARCOR stockholders.

Based on the current date for CLARCOR's special meeting with stockholders on February 23rd, 2017, and subject to the satisfaction of all closing conditions, Parker currently expects the pending CLARCOR transaction to close on or about February 28, 2017. All of us are really looking forward to welcoming the CLARCOR team to Parker.

Also note, yesterday we announced the acquisition of Helac Corporation. Helac specializes in the design and manufacture of helical rotary actuators and attachments. This is a nice bolt-on acquisition for our hydraulics group that expands our actuator platform, providing a broader bill of material that we can leverage through our global channels. We are happy to welcome the Helac team to Parker.

Last week we also announced a 5% increase in our quarterly dividend, consistent with our desire to extend our record of increasing annual dividends paid, which now stands at 60 consecutive years. These actions reinforce our commitment to being a great deployer of cash, in ways that generate increased long-term returns for our shareholders.

Now, moving to our revised FY17 guidance. We've increased our earnings guidance for FY17.

We are increasing our organic growth forecast for the second half of the fiscal year from 2.3% to 3.3%, at the midpoint in our new guidance. However, this increase in organic revenue is being offset by currency headwinds, resulting in essentially flat full-year reported annual sales growth versus FY16. For FY17, we are updating guidance for as-reported earnings in the range of $6.71 to $7.21 per share for $6.96 at the midpoint.

On an adjusted basis, we expect earnings-per-share in the range of $7.05 to $7.55, for a midpoint of $7.30. Earnings are adjusted for our anticipated business realignment expenses of approximately $0.25 per share forecasted for FY17, and for acquisition transaction-related expenses of $0.09, which were incurred in the second quarter.

Our revised guidance does not include any benefits or costs from CLARCOR or Helac acquisitions in Q3 and Q4 of FY17. Guidance will be updated for these acquisitions in our next earnings call. And for now, I will have things back to Cathy to review more details on the quarter and the FY17 guidance.

Okay. Thanks, Tom. At this time, please refer to slide number 5. I'll begin by addressing earnings per share for the quarter.

Adjusted earnings per share for the second quarter were $1.91, versus $1.52 for the same quarter a year ago. This equates to an increase of $0.39. FY17 second-quarter earnings include a gain on the sale of the product line of $0.21. Second-quarter earnings have been adjusted to exclude CLARCOR transaction expenses of $0.09 incurred during the quarter, and business realignment expenses of $0.04, which compares to business realignment expenses of $0.19 for the same quarter last year.

On slide number 6, you will find the significant components of the loss from adjusted earnings per share of $1.52 for the second quarter FY16 to $1.91 for the second quarter of this year. Increases to adjusted per-share income included higher adjusted segment operating income of $0.15, reduced other expense of $0.38 per share due to the sale of a product line, and a currency gain in Q2 of this year versus a currency loss in the same quarter last year, and the impact of fewer shares outstanding equated to an increase of $0.02 per share.

Adjusted per-share income was reduced by $0.09, due to a higher effective tax rate, as compared to the prior year. During Q2 of 2016, the tax rate was significantly reduced following the passage of the US tax extenders bill. Finally, higher corporate G&A versus prior year, as a result of favorable market-based incentive adjustments in the prior year, equated to a reduction of $0.07 per share this year.

Moving to slide number 7, we have reviewed total Company sales and segment operating margin for the second quarter. Total Company organic sales in the second quarter decreased by 0.5% compared to the same quarter last year. There was 0.3% contribution to sales in the quarter from acquisitions, while currency negatively impacted the quarter by 1.1%.

As Tom mentioned, total Company segment operating margin reached a second-quarter record of 14.4% on an as-reported basis. Total segment operating margins adjusted for realignment costs incurred was 14.7% versus 13.5% for the same quarter last year.

Business realignment costs incurred in the quarter were $8 million, versus $35 million last year. The increased adjusted segment operating income this quarter of $392 million, versus $366 million last year, reflects the impact of the new Win Strategy, complemented by increased progress toward stabilization in several industrial end markets.

Moving to slide number 8, I'll discuss the business segments, starting with the Diversified Industrial North America segment. For the second quarter, North American organic sales decreased by 2.8%, as compared to the same quarter last year. There was no impact from acquisitions, while currency negatively impacted the quarter by 0.6%.

Operating margin for the second quarter adjusted for realignment costs was 16.6% of sales, versus 15% in the prior year. Business realignment expenses incurred totaled $2 million as compared to $20 million in the prior year. Adjusted operating income was $186 million, as compared to $174 million, driven by favorable incremental margins.

I'll continue with the Diversified Industrial international segment on slide number 9. Organic sales for the second quarter in the Industrial international segment increased by 3.0%. Acquisitions positively impacted sales by 0.8%, while currency negatively impacted the quarter by 2.4%. Operating margin for the second quarter, adjusted for business realignment costs, was 13.1% of sales, versus 11% in the prior year.

Realignment expenses incurred in the quarter totaled $4 million, as compared to $14 million in the prior year. Adjusted operating income was $132 million as compared to $109 million, which reflects strong incremental margins on increased revenues and lower fixed costs.

I'll now moved to slide number 10 to review the Aerospace Systems segment. Organic revenues declined 1.6% for the second quarter. While growth in military OEM and military aftermarket was positive, commercial OEM continued to be negatively pressured in business jets, commercial helicopters, and wide-body commercial aircraft production, resulting in a modest year-over-year decline.

Operating margin for the second quarter adjusted for realignment costs was 13.5% of sales, versus 14.8% in the prior year. Business realignment expenses incurred in the quarter totaled $1 million, compared to minimal business realignment expenses in the prior year. Adjusted operating income was $74 million as compared to $82 million last year. Prior period margins benefited from comparatively high commercial aftermarket sales volume.

Moving to slide number 11, we have the details for orders, changes 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 improved to positive 5% for the quarter end. Diversified Industrial North American orders improved to a year over year 0% change. Diversified Industrial international orders increased year over year to positive 10% for the quarter, and Aerospace Systems orders grew year over year at a positive 9%.

On slide 12, we report cash flow from operations. Year to date cash flow from operating activities was $404 million, or 7.5% of sales. This compares to 6.5% of sales for the same period last year.

When adjusted for the $220 million discretionary pension contribution made in the first quarter, cash from operating activities was 11.5% of sales. This compares to 10.1% of sales for the same period last year adjusted for the $200 million discretionary pension contribution made in the prior year. In addition to the discretionary pension contributions, the significant uses of cash year-to-date were $196 million for the Company's repurchase of common shares, $169 million for the payment of shareholder dividends, and $72 million for capital expenditures, equating to 1.3% of sales.

The full-year earnings guidance for FY17 is outlined on slide number 13. Guidance is being provided on both an as-reported and an adjusted basis. Adjusted segment operating margins and earnings per share exclude expected business realignment charges of $48 million, which are forecasted to be incurred throughout FY17. Adjusted below the line items and earnings per share excludes CLARCOR transaction expenses of $16 million incurred during FY17 Q2.

Total sales are expected to be in the range of minus 2.3% to a positive 1.3%, as compared to the prior year. Organic growth at the midpoint is 4/10 of 1%. Acquisitions in the guidance are expected to positively impact sales by 0.4%.

Currency in the guidance is expected to have a negative 1.3% impact on sales. We've calculated the impact of currency to spot rates as of the quarter ended December 31, 2016, and we have held those rates steady, as we estimate the resulting year-over-year impact for the upcoming FY17.

For total Parker, as-reported segment operating margins are forecasted to be between 15.1% and 15.5%, while adjusted segment operating margins are forecasted to be between 15.5% and 15.9%. The midpoint of the forecasted adjusted margin is 110 basis points above FY16.

The full-year guidance at the midpoint for below the line items, which includes corporate G&A, interest, and other expense, is $425 million on an as-reported basis, and $409 million on an adjusted basis. The full-year tax rate is now projected at 27.5%.

The average number of fully-diluted shares outstanding used in the full-year guidance is 135.7 million shares. For the full year, the guidance range on an as-reported earnings per share basis is $6.71 to $7.21, or $6.96 at the midpoint. On an adjusted earnings per share basis, the guidance range is $7.05 to $7.55, or $7.30 of the midpoint.

This adjusted earnings per share guidance excludes business realignment expenses of approximately $48 million, to be incurred in FY17. The effect of this restructuring on earnings per share is approximately $0.25. Savings from these business realignment initiatives are projected to be $30 million, and are fully reflected in both the as-reported and the adjusted operating margin guidance ranges.

In addition, adjusted guidance excludes $16 million of CLARCOR transaction expenses incurred in Q2, equating to $0.09 earnings per share. Our revised guidance does not include any benefits nor costs from the CLARCOR or Helac acquisitions in Q3 and Q4 of FY17. Guidance will be updated for these acquisitions in our next earnings call. We would ask that you continue to publish your estimates using adjusted guidance, for purposes of representing a more consistent year-over-year comparison.

Some additional key assumptions for full-year 2017 guidance of the midpoint are sales are divided 48% first half, 52% second half. Adjusted segment operating income is divided 46% first half, 54% second half. Adjusted earnings per share first half, second half is $3.52 and $3.78 at the midpoint. Q3 2017 adjusted earnings per share is projected to be $1.74 per share at the midpoint, and this excludes $0.09 per share of projected business realignment expense.

On slide number 14, you will find a reconciliation of the major components of FY17 adjusted earnings per share guidance of $7.30 per share at the midpoint, from prior FY17 earnings per share of $6.75 per share. Increases include $0.09 from stronger Q2 segment operating income, $0.35 from lower other expense and $0.12 from lower SG&A expense, and a lower effective tax rate. The decrease includes a $0.01 per share reduction from slightly higher interest expense.

Please remember that the forecast excludes any acquisitions or divestitures that might close during FY17. This concludes my prepared comments. Tom, I will turn the call back to you for your summary comments.

Thanks, Cathy, and I am glad we were able to continue our progress through 2017, with a very strong second quarter. I would like to thank Parker team members around the world for their dedicated efforts.

We have made meaningful progress with initiatives designed to improve margins. We have also taken decisive actions to strengthen and sustain our business for the long-term, and create value for our shareholders. All signs point to an improving second half of FY17, and we are positioned for even greater success from the framework provided by the Win Strategy as we go into the future.

I'd also like to point out that Parker Hannifin celebrates its 100-year anniversary this year. We are very proud of the efforts put forth by all who have come before us, and the achievements we have made throughout our long history. Today, as the global leader in motion control technologies, we are focused on engineering the success of our stakeholders, as we work in partnership with our customers to solve the world's greatest engineering challenges.

With the actions and investments we are taking today, we are ensuring a bright future for Parker, as we enter our second century. And with that, at this time, we are ready to take questions, so Chelsea, if you want to go ahead and get us started?

(Operator Instructions)

Jeff Hammond, KeyBanc Capital Markets.

Okay, so maybe just first, can you just talk about anything that's really driving the more positive margins? Is that just feeling a little bit better about volumes?

And then, Tom, it looks like there is some corporate expense, lower corporate expense, if you exclude this gain. I'm just wondering what are the moving pieces there, and in particular, are there any savings captured by the simplification program? Thanks.

Okay, Jeff. This is Tom. I'll take the margin side, and have Cathy cover the corporate expenses.

The margins is really a holistic impact that we've seen, with the Win Strategy, and the changes we made to the Win Strategy. I would say we made clearly market adjustments when we saw the market turn down, we restructured the Company. But we've also done a strategic restructuring that focused combination of footprint and SG&A, and that combination has dramatically lowered our fixed cost structure of the Company.

I think probably the best way to visualize that for people is a line we put in the annual report this year, but we went from 59,000 people on the team going back probably about four years ago to 48,000 people. And we've done that through a variety of initiatives, responding to the market, looking at footprint, looking at SG&A, and in general trying to make the Company simpler, faster, easier to do business with, with our customers and ultimately that is what is driving the margin enhancements that you see.

The part that I am very encouraged by is that we're in very early days of this whole journey. We continue to find more upside and more positives as we work through this simplification program in particular has got lots of upside, and we're excited as orders are starting to turn, we'll get to leverage that lower fixed cost and generate even better margins.

But I'll let Cathy take the corporate expense question.

Yes, Jeff. The corporate expense had been impacted a little by a market-based incentive plan that we have. But I would say, in addition to that, we have done some realignment and movements to reduce some of the fixed costs at corporate, and you're seeing the benefit of that, as well.

Okay, great. And then just maybe just sticking on North America moving to flat, can you talk about the tone there, and maybe decipher between OE and distribution?

Maybe I will start with orders, and then since I notice this is a popular question, I just hand it to Lee to go through the markets by region because everybody, I'm sure, has questions about that. But in North America, the order pattern followed exactly what we had anticipated when we laid out the guidance last quarter. We expected it to get to flat at this quarter and it did.

In general, what's enabling that is the natural resource end markets, remember oil and gas, mining, construction and ag have moderated where they become less of a drag. We saw North America distribution go to flat, which being a big part of our total revenue, that was a huge help. And then in particular, semicon, telecom, refrigeration, machine tools and mining were positive order entry for North America.

Let me turn it over to Lee, and we'll spin you through the markets and the regions.

Okay, Jeff. You are going to get more than you asked for here, but I think first, just following up on Tom, I think what's encouraging is the organic growth moved largely in the direction we thought from the last call. Many of our markets are showing positive momentum towards year-over-year growth as they go around the world, and I'll share that with you.

Just on North American distribution, I would say in general the mood of our major distributors is fairly positive, and this is after solid order entry during the quarter. And that trend has continued in January, which has led us to the guidance that is reflected here today. And I think what's also encouraging is I checked, many of our largest distributors have reported an increase in their backlog, so again, bodes well.

If I talk about oil and gas on the Industrial side, land-based oil and gas is showing increasing signs of growth, which is real positive. There has been obviously, and we track this too, an increase in rig counts, which has led to an increase in MRO and some first bid activity. And we are seeing very small signs of recovery with offshore drilling contractors. We do expect the offshore to lag behind the land-based, but there's activity taking place there.

I think the best way to sum it up too, I was talking to one of our key partners in oil and gas, and he said Lee, 60, 90 days ago I would have said we see sparks, and today I'm starting to see smoke. So there's just things happening out there, which are positive.

Just talking about energy markets overall, the market for large frame turbines was flat in Q2. Our overall business was slightly up due to some market content wins. And we do continue to see positive year-over-year growth in alternative energy, such as wind turbines and Parker's benefiting mostly from significant content and customers try to take advantage of some of the federal tax credit programs that still exist.

Residential air-conditioning and refrigeration, Tom talked about, we continue to see strong year-over-year growth in commercial and residential air-conditioning. We expect that to continue going forward.

On the mobile markets in North America, most key customers are still showing year-over-year decline in Q2. This includes off-highway construction, farm and ag equipment, material handling. But we are getting many positive inputs and preparedness requests from many of our key OEM Partners, so I think that bodes well going forward. So I would call that segment, it appears that we have really formed a bottom with some upside.

Just turning to EMEA, and I will be brief here. On distribution, it's still slightly negative year-over-year. However, the distribution order entry is beginning to show signs of strengthening.

The order entry rates definitely improved during the quarter on a year-over-year comparison. Oil and gas is probably the biggest impact still in Europe, but it's flattened out, and we definitely see signs of strength in distribution that focuses on core Industrial end markets so that's positive.

Just in general Industrial, I would just say positive markets, like North America, we've seen a real uptick in mining and related equipment. This would be hard rock mining for iron ore et cetera and then semiconductor and telecom are both very strong.

Oil and gas I talked about, still very low year over year, but it does appear that a bottom has formed with the activity taking place in the North Sea. And then in the mobile markets, we do see an increased activity in forestry and off-highway construction equipment markets.

In Asia-Pacific I would say it's a very positive story, and it's really continued from a story we told last quarter. So in distribution, we're very encouraged by our focus in progress in distribution. The order entry was positive, and we continue to add new distribution outlets.

In the Industrial markets, almost all Industrial markets are positive year-over-year, and order entry continues to be strong. Strongest markets include machine tools, mining again, semiconductor is very strong, life sciences, and medical equipment.

And then in the mobile equipment markets that's probably perhaps the strongest sequential and year-over-year growth, and order entry came from those markets. And those strong end markets includes off-highway construction equipment, engines, cars and light trucks.

And just lastly I will touch on Latin America. We continue to be encouraged by Q2 order entry. As you know, Brazil still has its share of issues, but there are positives things taking place in ag, construction equipment, and in distribution. All obviously from a very low base.

So bottom line, organic growth continues to move in the direction we talked about, and I think we're all encouraged by what we see in many of our end markets and regions right now.

Ann Duignan, JPMorgan.

That was quite a summary, my head is spinning from all that information. I'll go back to the CLARCOR acquisition. If we look at some of the potential changes under the new administration, the elimination of interest expense is one that might impact Parker significantly post-CLARCOR.

Have you had any discussions instead of issuing debt, that you might use equity instead, just because of the uncertainty? Maybe you can tell us what you are talking about behind-the-scenes are?

Ann, I will take that. We are focused on issuing debt, we think it's a good time to be in the market at today's rates. We understand there could be some changes in rules around interest expense, but at this point, we do not plan to issue any equity. The agreement we have with CLARCOR that it is a cash deal.

I know you have said all along in the first year of ownership it will be, the deal will be accretive. If I just take the synergies that you've noted versus the cost that you've noted, we are looking at some around $0.15 of accretion in the first full year. Is that about the order of magnitude that you're looking at your first full year, or am I missing anything?

Yes, Ann, we are not really prepared to update from a we told you on December 1, but you're in line there, after excluding the one-off cost of the transaction fees, the inventory market valuation, and the synergy costs. But yes, we do expect to see it accretive in year one.

Okay finally on CLARCOR. They recently noted headwind from higher material costs. Does that change anything on the synergy side for you, or was that anticipated when you made the offer?

Ann, this is Tom. I won't comment about any of CLARCOR's comments, as they are still an independent Company. I just make a comment in general about what we've seen so far with integration planning.

It's really confirmed the excitement that we feel about the strategic fit, and the synergies that we communicated, $140 million in costs on December 1. So we feel as good or better about that today, and we really love the team that is joining Parker. And I think the cooperation that we've seen between both companies, both leadership teams has just been fantastic, and we're ready to hit the ground running when this thing closes.

Well great. I wish you luck on that, and I'll get back in line. Thanks.

Andy Casey, Wells Fargo Securities.

On the outlook, the guidance for Diversified Industrial international, the top line came down, margin went up from the prior guidance. Could you discuss what factors drove that? Was that all the divestiture or was there something else?

Andy, it is Tom. So for international, the big change is twofold. One the new guide organically is higher than what we told you before.

Last guide, we had 4.4% organic sales growth for the second half, these are all second-half numbers I've given you. And now it's 6.7%. However, when you look at currency, prior guide had a slightly positive currency, and now it is a minus 5% drag. So that's the big difference. Is that the currency impact basically is about $130 million swing from last guide to what we are guiding today, and that creates the headwind for us.

Okay, thanks, Tom. And then could you address the margin, slightly higher as well?

Oh, yes, the margins, it's the Win Strategy coming through, but in particular, you've all heard me talk about Asia-Pacific, how it's a region that is better margin than the Company average and relatively underutilized from a fixed cost and facility standpoint. So a lot of what's propelling our growth internationally so far is Asia-Pacific, so we're getting to leverage a little higher mix as Asia comes into the higher margins, and we're leveraging that fixed cost structure and converting it at a much faster clip, because the Asia team, everybody around the world has lowered their fixed cost, when you put some extra volume through a plant that's relatively underutilized, you get a really nice pop in margins.

Okay, thank you. And then if we look at the order improvement that you and Lee have gone through, we've heard some commentary that the fourth quarter, fourth calendar quarter your second quarter, had a surge at the tail end. First, did you see that? And then second, has there been any noticeable change to the trends you saw last quarter so far through January?

Andy, it is Tom again. I would characterize the order pattern for the quarter as steady progress sequentially through the quarter. So it kept improving gradually through the quarter and January continued, and our view of January in the quarter is all reflected in the revised guide, which popped the organic growth up 100 basis points for the second half.

Okay, thank you very much.

Nathan Jones, Stifel.

Tom, your total margin guidance has gone up about 30 basis points for the year, which would seem to have all been the beat in the second quarter. Can you talk about the margin guidance in the second half, relative to where you were before? And whether or not there were some one-time things that might've helped the 2Q number, or maybe you're just being conservative on the back half?

Nathan, it is Tom. So let me, I've got second half 2017 and second half 2016. I got to compared to the guide I don't know if I have the -- go ahead.

Nathan, a lot of the beat we saw in the second-quarter margins came from international, and as Tom described, a lot of that was driven by the performance in Asia Pacific. As we look at the guidance we're giving for the rest of the year, some of that gain shifts into North America doing better than we had previously thought, and that comes from the simplification efforts that we see coming through, and the realignment, and the lowering of fixed costs.

On the other end we're not promising as much from international as the currency headwinds, and just a little bit of doubt in what is going to happen with orders in Europe. We're being a little bit more conservative on the -- for international.

Okay, that helps. And so you also said 5 points of extra FX headwind relative to what you had forecast before. That dollar euro cross rate really hit the bottom, probably as we crossed into the new year. Is that the currency rate you used? And if we use the $1.08 it's at today, would that have a meaningful impact on where you guided the overall Industrial International for the year?

Yes, Nathan, we are using $1.05. As we measure the second half that's what we had as of the quarter ending December, so $1.08 would have some impact, which we have not built in.

Okay, that's helpful. And then if I could just do one on CLARCOR, you have got the $140 million of cost out targets. Is there any more granularity you can give us to that, in terms of what the main buckets are that $140 million goes into?

Nathan, this is Tom. At this point were not going to give you that granularity, probably we won't in the future either. Let me explain why.

We will clearly give you visibility how we're tracking to the $140 million, so we will give you progress updates to that number. We know that's important to all of our shareholders and to our analysts.

However the buckets underneath them, I can assure you have very clear visibility as to what they are. However, there is some obvious sensitivity to our people, and to our suppliers on how that might all play through, but we have very good granularity to that. And recognizing that as we start the integration really in full speed once we close, we're going to rely on the CLARCOR team who knows the business better than anybody to work side-by-side with us, to help fine tune what those buckets will be. But for a lot of reasons, we won't disclose the individual buckets, but will clearly give you, everybody, an update on the $140 million as we go every quarter.

Fair enough. Thanks very much.

John Inch, Deutsche Bank.

You are competing with GE before below the line moving parts, so I don't know who is ahead, I will come back to you on that.

So, Eaton on the last call prior to yours talked about their inability to recapture price in the short-term, given the rising raws. Is that part of why we are being so conservative on the organic for the next couple of quarters, even though you obviously seen some leverage and some pretty good growth signs out of Asia? If so, is there a way to quantify that, Tom?

John, it's Lee. First from a cost price standpoint, we're still slightly positive on price, so it's something if you followed us long enough, we try to really stay ahead of that. It's not a pricing environment we have seen in the past, but we're still slightly positive. And I would say on the organic growth guide, we're just trying to be as realistic as possible. It's early days right now. So we've done this bottoms up, with our regions, and some of our key customers, and that's what we're trying to reflect here.

Right. But I mean raw materials, specifically copper, steel et cetera, have gone up a lot. Do you anticipate, to my question, do you anticipate in the next couple of quarters, just because of that impact, some negative spreads in the next couple quarters that is baked into your guide? Or do you still think, Lee, you can sustain the flattish up slightly?

I think we can sustain it. Where we have got heavy content, usually we have contracts in place with our end customers where the pricing is adjusted because of the raw material increase. It's not a big portion of our business, but I think we all feel pretty comfortable about what we do internally to manage that.

Okay. Can I ask you about, when the dust settles here, how are you feeling about incrementals in your businesses, given the Win to, and other actions you've taken. It seems fairly clear volume's going to start at some point to grow again, not just because of compares, but it's actually going to start to grow. At what cadence is the $64,000 question. How are you thinking about future incrementals, call it beyond 2017? What can Parker really be doing here?

John, it is Tom. So would I think if you look at us traditionally, if you looked at a cycle regards along that cycle typically was, when we first came out, it was a pretty sharp inflection. We might be greater than 30% MROS, and then we come down to 30% MROS. Then when you start to glide down as you are deeper into an expansion, more into the upper teens.

I would just say that based on what we've been able to do and we will continue to work this, we will continue to see improvements, that you should see our margin on return on sales be better than what we have historically done over that cycle. And we're still confident, like we've been communicating, that we are going to get the Company to 17% operating margins in FY20.

And just as a last question, thanks for that Tom. Did anything actually get a little worse in the quarter, forgetting about all the moving parts, or at least adjusting for all the moving parts of incrementals and other stuff? Did anything actually get a little worse? Could be geographic or customer end markets from the trend?

John, it's Tom again. Nothing really got worse, but the only one that I would say is a pause was rail. Rail in particular in Asia, as the China government really took a pause in projects to reassess the activity there. But that's only one that I would say took a pause.

We expected automotive. Automotive went to slightly negative, but we expected that. So that would be about the only one I would call out.

Got it. Thank you. Appreciate it.

Jamie Cook, Credit Suisse.

Nice quarter. I guess two questions. One for you, Tom and the other one for Lee.

Tom, I feel like the story with Parker Hannifin has been you have continued to surprise on the upside on the margin front, even though the top line has been challenged. But I guess as I look at the sales trends that we're seeing, you are increasing your organic growth. Was this all just end market demand, or are you further ahead versus where you thought you would be in terms of you being able to outgrow your market? Are we starting to see any of those benefits?

And then my second question, Lee, you noted two things when you are talking about order trends. One, looking at the mobile equipment side, you said the preparedness to refresh or something. Can you just give more color on that and whether you have incorporated what they are telling you in your numbers? Or they haven't put that in the numbers yet?

And then on the distributor side, it sounds like things are more positive there, but how are inventory levels at the distributor side? Just wondering if they need to restock more, or if they're still being a little more conservative, because we don't know if this trend is real?

Okay, Jamie, it is Tom. I'll start first as far as basically what you're asking is our efforts to try to grow 150 basis points faster than the market, have we started to feel that yet? I would say at this point, most of what we're seeing is end markets getting better.

Okay.

Natural resource end markets is becoming of a drag. Distribution moving to neutral, PMIs trending positively across the world, have all yielded better order entry patterns.

However, that being said, when I look at the ones that are nearer-term on our list of organic growth actions, the focus we've had on international distribution, and trying to convert competitive product, add distribution outlets, we've seen good traction on that. There's a lot of visibility to that across the Company, and so I think that one, we are starting to feel some of that.

We have a very concerted effort on really just tracking opportunities across the world by account managers. We have probably have our sales team better organized than we ever had around our global OEMs. We've updated our incentive plan, as all of you know, around the growth multiplier times return on net assets.

So I think all those are starting early traction, but I would say they're in the first inning of our march to grow 150 basis points faster than the market. If we grow 3.3% in the second half, which is in our guidance, we will be growing faster than the Industrial production growth. So that will be the first indicator that what we are doing is starting to take hold.

I will let Lee chime in.

Thank you.

Jamie, you're going to have to remind me on the distribution question again, but on the preparedness question. So just dealing with some of our customers that have been suppressed for some time, they are starting to have conversations with us now looking forward. It's mostly towards 2018, to be candid with you. Just about being prepared, because they do have an anticipation there is going to be some growth here. So it seems to be, you walk away with the sense that things have plateaued, hit a bottom, and let's just talk what's going to be happening going forward.

And was that fairly broad across the mobile equipment market, or specific to one?

Fairly broad.

Okay, and sorry, the second question, just on the distributor level. Are they sitting there, are your distributors sitting there with inventories that are at low levels, have they restocked yet? I'm just trying to get a feel for?

No, I would not characterize the channel is inventory heavy at all. And some of them that were tied to oil and gas and did get stuck with some inventory. I would say by and large that's not 100% gone, but it's burned off quite a bit. So I don't consider the channel heavy at all.

Okay, thank you, I will get back in the queue.

Jeffrey Sprague, Vertical Research.

I wanted to come back to the margin execution, I think it plays a little bit off John's question. Very strong decrementals when revenues were declining, and you used the term incremental here today, but really revenues aren't up, so to some degree the construct doesn't apply, right? So we're seen pretty nice step up in margins without help from revenue in this quarter.

Just wondering if you could give us a little bit of insight into what drove that combination of win execution but perhaps there was some favorable mix going on? And again it's really, the question's aimed at getting comfort on that incremental trajectory, once the revenues do in fact begin to go the other way?

Jeffrey, it's Tom. Hopefully collectively everybody listening on the call is starting to get more comfortable with that, because we have demonstrated our ability to hold decrementals for seven or eight quarters in a row, and you described exactly what happened. So we now have favorable where we're growing margins, growing operating income with flat, slightly declining sales.

It's really a combination of things. We do get some help last quarter with Asia growing like it did, and leveraging that fixed cost structure that I talked about. Remember Asia, most of our factories we invested in probably seven, eight years ago and they are running a shift maybe a little over a shift. So any incremental volume we put through there is nice utilization for us.

But is a combination of things. We've made very aggressive market adjustments when order entry went down the last two years, and we've been very focused on strategically reshaping the Company through looking at revenue complexity, division consolidations, organization design, process redesign, just making the Company easier, faster and we're still in very early days at this. I think there's tremendous upside here, which is a big part of what is going to lift us to the 17% operating margin.

So I can't pick one particular thing, I think we were smart several years ago to get ahead of this with the restructuring we did. We've continued that, and we have layered on top of that a little more strategic look at the Company, looking at the SG&A for the Company. Our fixed costs are down, and so it's easier to convert when we have order entry showing positive volume increase.

Very impressive. And just looking forward, how do you judge the balancing act between maybe stepping on the throttle on new product investment, and the like, as you do get a bit of revenue tailwind? Do you feel as if you can clearly drive to those margin targets and step up to the next level of investment to drive the top line?

Yes, absolutely, because part of why new products are a big part of -- two things. One, our organic growth as well as market expansion, because if you look at our profile of margins for new products, they tend to be higher than the average margins of the Company. So they will be incremental for both of that.

There is a big focus on that across the Company. We've got a dashboard that looks at what our new product vitality is, and how we are doing.

I think it's been somewhat camouflaged with the end market deterioration that we saw, and the dramatic downturn of natural resources. But there's a lot of activity there and we're making investments from a corporate standpoint at the group level and division that is in there today. And I think that's, when we talk about growing faster than the market, that will be a big element of it.

Thank you.

Eli Lustgarten, Longbow Securities.

Just a clarification, and I apologize for asking. In the $7.30 for year, so it looks like we had $0.38 in the quarter, $0.35 of what you would call non-recurring earnings to use a base for 2018. So the $0.21 and you have a foreign currency gain, is there any more foreign currency gain expected? But we use it as a base for FY18.

Should we be using closer to $7 with the two things out, if we're looking at it? And the same thing in tax rate, 27.5% as we go back to a more normalized tax rate, before politics of the 28.5% that we expected for the year?

Eli, we have not forecasted any additional currency gains. We have flat for currency in terms of transactional gains or losses, and in terms of the other part of the question?

You show $0.35.

Tax rate, you asked about the tax rate. We are getting a benefit this year from the new accounting rule related to stock options that get exercised at a gain. We have not forecasted for that going forward, because we really can't predict who will exercise, and at what gain, and so we have not built any of that in. So I would assume that the tax rate would not stay as low as the 27.5% that we are forecasting for this year. I would expect it to go back up.

And it's fair to say that about $0.35 or some number in that range is a nonrecurring number as a basis, because of the sale of the division and foreign currency gain, that we shouldn't use it as a base to forecast 2018?

Yes, I think that's fair.

Fair. I just wanted to make sure. And started looking at the organic numbers that you are starting to see. You have modest organic gains in North America, internationally I understand, but you are looking at modest North American gains in the second half of this year into next year, or are we still on the low single-digit gains?

Yes, Eli we've got 1/2% for North America. Really what we tried to mirror in this guide is what happened in Q2 on order entry and what we saw in January in North American came in flat, and we are anticipating a little bit of upside there, hence we put 1/2% of organic, and most of the upside we put organically was international based on the order entry we saw.

Just to tag onto that, are you hearing anything from your customers? There's a lot of -- we hear a lot of talk everybody is optimistic, but almost being mood cautious in the first half of the year, which is the second half of your year, just because lots of optimistic for policy, but nothing is happening, and you want to see what happens. Is that part of the conservatism that we're seeing? From your customers and from you?

Well, Eli, this is Tom. I think the way you described it is probably fair. Until you see policy discussions turn in to policy, which turns into action, you can't tell.

But when we do our forecast, and I [honestly] think 6.7% international organic growth for second half is conservative, I think it's a pretty good number. We're just reflecting what we saw order entry so far, and we'll update it next quarter if we see something different. But so far so good on that.

I appreciate it, I was really talking about North America, I was wasn't talking about international. Thank you very much.

Joe Giordano, Cowen and Company.

Most of my stuff has been answered, so I'll shift over the aerospace a little bit. I have to look back, but I don't remember you calling out wide bodies specifically over the last couple of quarters. Is there anything specific, what are you seeing there? And when did the biz jet comps start not working against you?

I'll start with the biz jet. I think part of the biz jet will come back when oil and gas comes back, and there's just more demand for it.

In terms of the wide body production, yes, we haven't seen the level of delivery requests for the 777 and the 747, and we really don't expect that coming forward until the 777X comes into production. The wide body just does not come through at the demands that we had hoped.

So, how we reconcile that with order entry. Is where we are now pretty good run rate you are thinking into 2.5% for now?

Yes, we are expecting organic growth in the second half a little over 3%. I would say for the longer-term, as aerospace orders tend to be, we're looking at about a 3% organic growth over the next several years. We still, long-term expect as new planes come into entry into service, that that will continue to grow, and our long-term projection remains about a 4% growth for aerospace.

So your second half protection doesn't inherently assume any sort of change from the current outlook on biz jet, or like what you just mentioned on 777 and 747?

Correct.

Okay. Thanks.

Joshua Pokrzywinski, Buckingham Research.

Just a couple questions. First on oil and gas, it sounds like you're not seeing the turn yet, but what's the lead time you would normally expect from the pickup in rig count, versus when you start to see the orders? Acknowledging that distributor inventories are probably not overstocked anymore?

We are starting to see some positives in North America. I mean obviously, there's been some inventory that has burned off, but if you look at the rig count year-over-year on land base, it is up significantly from the low levels that it was.

I would put lead times in that same 30 to 60 day bucket, on projects that are done, and the way it is ordered. So it's fairly short cycle, if you would characterize it that way.

Got you so you can see an improvement.

Sure.

Or further momentum this quarter. Okay.

Sure, yes.

And just snapping along, because I know there was some initial volatility in what you thought you would have for financing costs on CLARCOR. What's the read on that today? I think you started out that 100 and maybe thought there could be some downside to that. How are we recalibrating that with current markets?

Yes, Josh, we've been watching the interest rates very closely. We're still on the path of using about $1.5 billion of our cash available, and $3 billion of new debt. That new debt will be a combination of short and long-term.

As we're watching the rates, we do have the capability of pulling a bridge loan from Morgan Stanley, and we also have plenty of room in our commercial paper. So we'll watch the market, and we'll take an opportunistic opportunity to jump in, in both short-term and long-term debt when we see it best available for us.

So there's no big delta you see it today in those financing costs?

No, I think the $100 million that we told you earlier is still a good estimate.

Okay, thanks a lot. Good luck.

Okay, thank you. So this concludes our Q&A session, and our earnings call for today. Thank you, everybody for joining us.

Robin and Ryan will be available throughout the day to take your calls, should you have further questions. Thank you, everybody, and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.