Parker-Hannifin Corporation (PH) Q2 2017 Earnings Report, Transcript and Summary

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 fiscal year 2017 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 1 year following today’s call. On Slide #2, you will find the company’s Safe Harbor disclosure statement addressing forward-looking statements as well as non-GAAP financial measures. Reconciliations or 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 #3. To begin, our Chairman and Chief Executive Officer, Tom Williams, will provide highlights for the second quarter of fiscal year 2017. Following Tom’s comments, I will provide a review of the company’s second quarter fiscal year ‘17 performance, together with the guidance for fiscal year ‘17. Tom will provide a few summary comments, and then we will open the call for a question-and-answer session. This time, I will turn it over to Tom and ask that you refer to Slide #4.

Thanks, Cathy and welcome to everybody on the call and we appreciate your participation this morning. Today, I would 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 fiscal 2017 guidance. As I have shared before, keeping our people safe is our first priority, so I thought I’d once again report on that first. During the second quarter of 2017, we are able to reduce our recordable injuries by 31% compared to the prior year. This builds upon a 33% year-over-year improvement we posted comparing 2016 to 2015. This improvement is being driven by a combination of strong leadership, training and 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 with the progress we are making. Now to the financial highlights of our second quarter results. Overall, this was 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 then 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 pre-tax 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 a second quarter record at 14.4% as reported or 14.7% on an adjusted basis. Adjusted segment operating margins increased 120 basis points compared with the second quarter of fiscal 2016, 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. Transaction remains subject to other closing conditions, including approval by the CLARCOR stockholders. Based on the current date for Parker’s special meeting on the stockholders on February 23, 2017 and subject to the satisfaction of all closing conditions, the parties currently expect 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 FY ‘17 guidance. We have increased our earnings guidance for fiscal 2017. 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 fiscal 2016. For fiscal year 2017, we are updating guidance for as-reported earnings in the range of $6.71 to $7.21 per share or $6.96 at the midpoint. On an adjusted basis, we expect earnings per share in the range of $7.05 to $7.55 or midpoint of $7.30. Earnings are adjusted for anticipated business realignment expenses of approximately $0.25 per share forecasted for fiscal 2017 and for acquisition of 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 fiscal 2017. Guidance will be updated for these acquisitions in our next earnings call. And for now, I will hand things back to Cathy to review more details in the quarter and the fiscal 2017 guidance.

Okay. Thanks, Tom. At this time, please refer to Slide #5. I will 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. Fiscal year ‘17 second quarter earnings include a gain on the sale of a 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 #6, you will find the significant components of the walk from adjusted earnings per share of $1.52 for the second quarter FY ‘16 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 again 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 ‘16, the tax rate was significantly reduced following the passage of the U.S. 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 #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 realigned – sorry, 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 towards stabilization in several industrial end markets. Moving to Slide #8, I will 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 margins 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 will continue with the Diversified Industrial International segment on Slide #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 will now move to Slide #10 to review the Aerospace Systems segment. Organic revenues declined $0.016 – 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 widebody 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 #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 a positive 5% for the quarter end. Diversified Industrial North American orders improved to a year-over-year zero percent 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 contribution, 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 fiscal year 2017 is outlined on Slide #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 fiscal year 2017. Adjusted below the line items and earnings per share exclude CLARCOR transaction expenses of $16 million incurred during fiscal year ‘17 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 0.4%. 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 have 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 fiscal year 2017. 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 fiscal year 2016. 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 at the midpoint. This adjusted earnings per share guidance excludes business realignment expenses of approximately $48 million to be incurred in fiscal year 2017. 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 fiscal year 2017. 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 at 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 ‘17 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 expenses. On Slide #14, you will find a reconciliation of the major components of fiscal year ‘17 adjusted earnings per share guidance of $7.30 per share at the midpoint from prior fiscal year ‘17 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 fiscal year ‘17. 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, but 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 fiscal 2017 and we are positioned for even greater success under the framework provided by the Win Strategy as we go into the future. I would also like to point out that Parker-Hannifin celebrates its 100th 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.

Certainly. [Operator Instructions] And our first question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is now open.

Hey, good morning guys.

Good morning, Jeff.

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. And I am just wondering what are the moving pieces there and then in particular, are there any savings captured by the simplification program? Thanks.

Okay, Jeff. This is Tom. I will take the margin side and I will have Cathy cover the corporate expenses. But the margins is really a holistic impact that we have seen with the Win Strategy and the changes we have 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 have 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 the line we have put in the annual report this year, but we went from 59,000 people on the team, going back probably about 4 years ago, to 48,000 people. And we have 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’s what’s driving the margin enhancements that you see. The part that I am very encouraged by is that we are 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, it’s got lots of upside. And we are excited as orders are starting to turn, we will get to leverage that lower fixed cost and generate even better margins. But I will let Cathy take the corporate expense question.

Yes, Jeff. The corporate expense has 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 are seeing the benefit of that as well.

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

Maybe I will start with orders. And then since I know this is a popular question, I will just hand it to Lee to go through the markets kind of 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 that it get to flat this quarter and it did. In general, what’s enabling that is that the natural resource end markets kind of oil and gas, mining, construction and ag have moderated to where they have 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. But let me turn it over to Lee and we will kind of 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. And many of our markets are showing positive momentum towards year-over-year growth as I go around the world, and I shared 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 a 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. I think what’s also encouraging is I checked many of our largest distributors have reported 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 you 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 is 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 am starting to see smoke. And so there is 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 is benefiting mostly from significant content and customers trying 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 and 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 the 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 have seen a real uptick in mining and related equipment. This would be hard rock mining for iron ore, etcetera and then semiconductor and telecom are very – both very strong. Oil and gas, I talked about, still very low year-over-year, but we – it does appear the 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 the story we told last quarter. So in distribution, we are very encouraged by our focus and progress on distribution. The order entry was a 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 include off-highway construction equipment engines, cars and light trucks. And then 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 some positive things taking place in Ag, construction equipment and then distribution, all obviously from a very low base. So bottom line, organic growth continues to move in a direction we talked about. And I think we are all encouraged by what we see in many of our end markets and regions right now.

Thank you. And our next question comes from the line of Ann Duignan with JPMorgan. Your line is now open.

Thank you. That was quite a summary, my head is kind of spinning from all of that information, but I will go back to that 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 have any discussions about, instead of issuing debt that you might use equity instead just because of the uncertainty or maybe you could just tell us what you are talking about behind the scenes there?

Yes. 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. Yes, we understand that 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’s a cash deal.

Okay. And I know you have said all along that in the first year of ownership, it would be – the deal would be accretive, if I just take the synergies that you have noted versus the costs that you have noted, we are looking at somewhere around $0.15 of accretion in the first full year, is that about right, is that the order of magnitude that you are looking at in first full year or am I missing anything?

Yes. Ann, we are not really prepared to update from what we told you on December 1, but that’s you are in line there, after excluding the one-off costs 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. And just finally on CLARCOR, they recently noted headwinds from higher material costs, does that change anything on the synergies 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 will just make a comment in general about what we have 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 cost on December 1. So we feel as good or better about that today. And we really love the team that is joining in Parker. And I think the cooperation that we have seen between both companies, both leadership teams, this has been fantastic and we are ready to hit the ground running when this thing closes.

Well, great. I wish you luck on that. Now, I will get back in line. Thanks.

Thanks Ann.

Thank you. And our next question comes from the line of Andy Casey with Wells Fargo Securities. Your line is now open.

Thanks a lot. Good morning.

Good morning Andy.

On the outlook, the guidance for Diversified Industrial International, the top line came down, margin went up from the prior guidance, could you kind of discuss what factors drove that was that all the divestiture, or was there something else?

Andy, it’s Tom. So for international, the big change is two-fold. One, the new guide organically is higher than what we told you before. So last guide, we have 4.4% organic sales growth for the second half. These are all second half numbers I have given you. And now it’s 6.7%. However, when you look at currency, prior guide had a slightly positive currency and now it’s a minus 5% drag. So that’s the big difference, is that a 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 margins slightly higher as well?

The margins, I mean it’s the Win Strategy coming through. But in particular, we are leveraging – you have 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 are getting to leverage a little higher mix as Asia comes in higher margins and we are leveraging that fixed cost structure and converting it at a much faster clip because the Asia team – everybody around the world is lowering 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 kind of look at the order improvement that you and Lee have gone through, we have heard some commentary that the fourth quarter - fourth calendar quarter, your second quarter, had kind of a surge at the tail end, first, did you see that and then second, has there been any noticeable change to the trend you saw last quarter so far through January?

Andy, it’s 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 really our view, 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.

Thank you. And our next question comes from the line of Nathan Jones with Stifel. Your line is now open.

Good morning everyone.

Good morning Nathan.

Tom, your total margin guidance has gone up about 30 basis points for the year, which would seem to have all been debate 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 that there were some one-time things that might have helped the 2Q number or maybe you are just being conservative on the back half?

Okay. Nathan, it’s tom. So let me – I have got second half ‘17 to second half ‘16. All I have got, I got to compare it to the guide. I don’t know if I have them.

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 are 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 are not promising as much from international as the currency headwind and just a little bit of doubt in what is going to happen with orders in Europe. We are being a little bit more conservative on the – for international.

Okay, that helps. And so you had also said 5 points of extra FX headwind relative to what you forecast before, that dollar-euro cross rate really hit the bottom probably at – as we crossed into the New Year, is at the currency rate you used and if we used 1.08 that it’s at today, would that have a meaningful impact on where you had 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 yes, 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 anymore granularity you can give us to that in terms of what the main buckets are that, that $140 million goes into?

Nathan, it’s Tom. At this point, we are not going to give you that granularity, probably won’t in the future either. Let me explain why. We will clearly give you visibility how we are tracking the $140 million, so we will give you progress updates to that number if we know that is important to all of our shareholders and to our analysts. However, the buckets and I can assure you we 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 related to full speed once we close, we are 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 there is probably lot of reasons we won’t disclose individual buckets, but we will clearly give you everybody an update on the $140 million as we go every quarter.

Fair enough. Thanks very much.

Yes. Thank you, Nathan.

Thank you. And our next question comes from the line of John Inch with Deutsche Bank. Your line is now open.

Yes, thank you. Good morning, everyone.

Good morning, John.

Good morning. You are competing with GE for below-the-line moving parts, so I don’t know who is ahead, but I’ll come back to you on that. So Ethan, on the last call prior to yours, talked about their inability to recapture price in the short-term given the rising ROS. Is that part of why we are being so conservative on the organic for the next couple of quarters even though you have obviously seen some leverage and some pretty good growths signs out of Asia? And if so is there a way to quantify that, Tom?

John, it’s Lee. First, from a cost price standpoint, we are 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 are still slightly positive. And I would say, on the organic growth guide, we are just trying to be as realistic as possible. I mean, it’s early days right now. So, we have kind of done this bottoms-up and with our regions and some of our key customers and that’s what we are trying reflect here.

Right. But I mean, but raw materials, specifically copper steel, etcetera have gone up a lot. So 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 of quarters that’s baked into your guide or do you still think, Lee, you can sustain kind of 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 and 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 sort of when the dust settles here, how are you feeling about incrementals in your businesses, given the win to and other actions that you have taken? I mean, it seems fairly clear volume is going to start at some point to grow again, not just because of compares, but it’s actually really going to start to grow. At what cadence is the $64,000 question? But how are you guys thinking about future incrementals, call it, beyond ‘17 just what can Parker really be doing here?

John, it’s Tom. So I would think if you look at us traditionally, if you look at a cycle regardless how long that cycle typically was, when we first come out, there is a pretty sharp inflection, we might be greater than 30% MROS and we come down to 30% MROS. Then 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 have been able to do and we will continue to work as we will continue to see improvements that you should see our margin return on sales be better than what we have historically done over that cycle. And we are still confident like we have been communicating that we are going to get the company to 17% segment operating margins in FY ‘20.

Did anything – this is the last question, thanks for that, Tom, did anything actually get little worse in the quarter, forgetting about all the kind of moving parts of – 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 was a pause was rail. Rail, in particular, in Asia as the China government really kind of took a pause in projects to reassess the activity there. But that’s the only one that I would say took a pause. We expected automotive, automotive went slightly negative, but we expected that. So that would be about the only one I would call out.

Got it. Thank you. Appreciate it.

Thank you. And our next question is from the line of Jamie Cook with Credit Suisse. Your line is now open.

Hi. Good morning and nice quarter. I guess two questions, one for you, Tom, and then the other one for Lee. Tom, I feel like the story with Parker-Hannifin has been you guys 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 are seeing, you are increasing your organic growth. Was this all just sort of end market demand or you further had 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 were talking about sort of order trends. One, I think on the mobile equipment side, you have said like 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 their numbers yet? And then on the distributor side, I mean, it sounds like things are more positive there, but how are inventory levels at the distributor side? I am just wondering if they need to restock more or if they are still sort of being a little more conservative because we don’t know if this trend is real.

Okay, Jamie. It’s Tom. I will start first as far as basically what you are asking our efforts to try to grow 150 basis points faster than the market, have we started to feel that yet. And I would say at this point, most of what we are seeing is end markets getting better, natural resource end markets becoming less of a drag, distribution moving to neutral, the 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 near-term on our list of organic growth actions, the focus we have had on international distribution and trying to convert competitive product, add distribution outlets, we have seen good traction on that. There is a lot of visibility into that across the company. And so I think that when 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 probably have our sales team better organized than we ever had around our global OEMs. We have updated our incentive plans, as all of you know, around the growth, a growth multiplier times a return on net assets. So I think all of those are starting to early traction, but I would say during the first inning of our margins 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 industrial production growth, so that will be our first indicator that, hey, what we are doing is starting to take hold. Now I will let Lee chime in.

Yes, Jamie, you are 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, we are starting to have conversations with us now looking forward. And 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 will walk away with the sense that things have kind of plateaued, hit a bottom, and let’s just talk about 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 so the second question just on the distributor level, like, are they sitting there? Are your distributors sitting there with inventories that are low levels? Have they restocked yet? I am just trying to get a feel for...

No, I would not characterize the channel as inventory heavy at all. And you know some of them that were tied to oil and gas 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 queue.

Thanks, Jamie.

Thank you. And our next question comes from the line of Jeffrey Sprague with Vertical Research. Your line is now open.

Thank you. Good morning.

Good morning Jeff.

I want to come back to the margin execution, I think it plays a little bit of John’s question, but 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 are seeing a pretty nice step-up in margins without help from revenue this quarter, just wondering if you could give us a little bit of insight into what drove that kind of a combination of win execution, but perhaps there was some favorable mix going on. And again, it’s really the question being that kind of getting comfort on that incremental trajectory once the revenues do in fact begin to go the other way?

Yes. Jeffrey, it’s Tom. Hopefully, you are – collectively everybody listening on the call starting to get more comfortable with that because we have demonstrated our ability to hold the decrementals for like seven quarters or eight quarters in a row and what you described is likely what happened. So we now have favorable growing margins, growing operating income with flat slightly declining sales. It’s really a combination of things. We did do get some help last quarter with Asia growing like it did and leveraging that fixed cost structure that I talked about. Remember Asia, see most of our factories we invested in probably 7 years, 8 years ago and they are running the shift may be able over a shift, so any incremental volume that we put through there is nice utilization for us. But it’s a combination of things. We have made very aggressive market adjustments when ordering went down in the last 2 years and we have been very focus on strategically reshaping the company through looking at revenue complexity, division consolidations, organization design, process redesign, just making the company easier, faster. And we are still in very early days at this. I think there is tremendous upside here, which is a big part of what’s 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, what the restructuring we did and we have continued that. And we have layered on top of that the most strategic look at the company, looking at the SG&A for the company. Our fixed costs were down and so it’s easier to convert when we have quarter 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 for those margin targets and step up to kind of the next level of investments to drive the top line?

Yes, absolutely. I mean because part of why new products are a big part of two things; one, our organic growth as well as margin expansion because if you look at our profile of margins for new products, they are tend to be higher than the average margin for the company. So they will be incremental for both of that. There is a big focus on that across the company. We have 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 in the dramatic downturn of natural resources. But there is a lot of activity there and we are making investments from a corporate standpoint at the group level and division that’s 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.

Thank you. And our next question comes from the line of Eli Lustgarten with Longbow Securities. Your line is now open. Eli, if your phone is on mute, please un-mute it.

Can you hear me now?

Yes. Good morning Eli.

I am sorry. Just a clarification and I apologize for asking, in the 7.30 for the year, so it looks like we had $0.38 in the quarter or $0.35 of what you would call sort of non-recurring earnings fees as a base for 2018, does it fare – the $0.21 and you have a foreign currency gain, is there anymore foreign currency gain expected, but I just want to say we use it as a base for fiscal ‘18, should we use in closer to $7, like two things out before looking at it and the same thing in tax rate, 27.5 would we go to a normalized tax rate before any politics of the 28.5% that we sort of expected for the year?

Yes. 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 prior question...

I mean you showed 35…

Sorry, 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 that 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 is it fair to say that about $0.35 or some number in that range is a non-recurring number as a basis because of the sale of the division and in foreign currency gain that we shouldn’t use it as a base to forecast ‘18?

Yes, I think that’s fair.

Okay. I just want to make sure and started looking at the organic numbers that you are starting to see, you have minus organic gains in North America, international, I understand, but you are looking at modest North American gains in the second half of this year into next year, what’s on the low single-digit gains?

Yes. Eli, we have got 0.5% for North America. Really, what we tried to mirror in this guide is what happened in Q2 on order entry and what we saw on January and North America came in flat and we are anticipating a little bit of upside there. Hence, we put 0.5% of organic and most of the upside we put organically was international based on that strong order entry we saw.

And just to tag on to that, are you hearing anything from your customers, there is a lot of – you hear a lot of talk, everybody is optimistic, but almost sort of being a little cautious in the first half of the year, which is the second half of the year, just because lots of optimistic for policy, but nothing happening when you see what happens, is that part of the conservatism that we are seeing from your customers and from you?

Well, Eli, this is Tom. I think the way you describe it is probably fair. I mean I think until you see the policy discussions turning to policy, which turns into action, you can’t tell. But we do our forecast and I don’t want to say 6.7% international organic growth for the second half was conservative. I think that’s a pretty good number. And we are just reflecting what we saw order entry so far and we will update it next quarter if we see something different, but so far so good on that.

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

Okay. Thanks Eli.

Thank you. And our next question comes from the line of Joe Giordano with Cowen and Company. Your line is now open.

Hey guys, how are you doing?

Hi Joe.

I guess most of my thoughts have been answered, so I will shift over to Aerospace a little bit, I have to look back, but I don’t remember you guys calling out widebody specifically over the last couple of quarters, is there anything specific, what are you seeing there and when did the bizjet comps start not working against you?

So I will start with the bizjet. I think part of the bizjet will come back when oil and gas comes back and there is just more demand for it. In terms of the widebody production, yes, we have just – 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. So the widebody just does not come through at the demands that we had hoped.

So is it – like how do we reconcile that with like order entry, like what kind of – is like where we are now pretty good run rate you thinking into that for now?

Yes. We are expecting organic growth in the second half of a little over 3%. I would say, for the longer term, as Aerospace orders tend to be, we are 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 production remains at about a 4% growth for Aerospace.

Okay. So your second quarter half production doesn’t inherently assume any sort of change from the current outlook on bizjet order like what you just mentioned on 777 and 747?

Correct.

Okay. Thanks guys.

Okay. Thank you. And we will take one more question.

Thank you. And our last question comes from the line of Joshua Pokrzywinski with Buckingham Research. Your line is now open.

Hi, good morning. Thanks for letting me in.

Sure Josh, good morning.

Just a couple of questions, I guess first on oil and gas, it sounds like you are not seeing the turn yet, but what’s the sort of 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?

Well, if we are starting to see some positives in North America, I mean obviously, there has been inventory that’s burnt off. But if you look at the rig count year-over-year, it’s on land based, it’s up significantly from the low levels that it was. I would put lead times in the kind of that same 30-day, 60-day bucket on projects that are done and the way it’s ordered. So it’s fairly short cycle, if you would characterize it that way.

Got it. So you could see an improvement more on the – further momentum this quarter?

Sure.

Okay. And then just snapping volume, because I know that there was some initial volatility and what you guys thought you would have for financing costs on CLARCOR, what’s the rate on that today, I think you started out at 100 and then maybe thought there could be some downside to that and how are we recalibrating that with the current markets?

Yes. Josh, we have been watching the interest rates very closely. We are 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-term and long-term. As we are watching the rates, we do have the capability of use – pulling a bridge loan from Morgan Stanley and we also have plenty of room in our commercial paper. So we will watch the market and we will take an opportunistic opportunity to jump in, in both short-term and long-term debt when we see it best available for us.

But there is no big delta as 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.

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.