Parker-Hannifin Corp (PH) — Q4 2015 Earnings Call Transcript

Thank you, Mark, good morning and welcome to Parker Hannifin's fourth-quarter 2015 earnings release teleconference. Joining me today is Chief Executive Officer, Tom Williams and President and Chief Operating Officer, Lee Banks. Today's presentation slides together with the audio webcast replay will be accessible on our company's Investor Information website at www.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 or any reference to non-GAAP financial measures are included in this morning's press release and are posted on Parker's website at www.phstock.com. Continuing on to slide number 3, I just want to point out the agenda for today's call. To begin our CEO, Tom Williams, will provide highlights for the fourth quarter and full-year 2015. And then following Tom's comments I will provide a review of the company's fourth-quarter and full-year 2015 performance together with the guidance for 2016. Tom will provide a few summary comments and then we will open the call for a Q&A session. At this time I will turn it over to Tom and ask that you refer to slides number 4 and then 5.

Thank you, Jon and welcome to everybody on the call. We appreciate your participation today. I'm going to take a few minutes to share our thoughts on the fourth quarter and our full-year results. I will also touch briefly on some of our end market conditions and provide an update on the upcoming rollout of the refreshed Win Strategy. This includes a focus on our new simplification initiatives, some of which you have already, are already being implemented. I'd like to start with a few comments on our fourth quarter. We're operating in a tough environment as we continue to feel the effects of the strengthening dollar and ongoing weak conditions in some key end markets. Throughout the quarter we continued with actions to adjust to these conditions, including the completion of a voluntary retirement program in the United States and a broad range of other actions to reduce costs globally such as reductions in force, reduced work schedules and tight control of discretionary spending. Sales declined 11% in the fourth quarter as the effects of changes in currency rates negatively impacted us by 6% and organic sales declined 5%. Order rates were 9% lower than the fourth quarter compared with the same quarter last year. This follows a 4% decline in the third quarter. We're working hard to align costs with such a swift change in order rates. All things considered I am pleased we delivered total adjusted segment operating margins of 14.9%. This compares to 15.0% adjusted in last year's fourth quarter. Folding adjusted segment operating margins flat while sales declined 11% is a nice accomplishment. Earnings per share were $1.27 or $1.43 adjusted for business realignment and the voluntary retirement program. Earnings were impacted by a higher effective tax rate through largely the changes in the geographic mix of pretax profits. This equated to a $0.30 negative impact to our Q4 2015 guide. Operating cash flow for the quarter was very strong at $511 million or 16.2% of sales. In regards to our performance for the full year, considering all the challenges we faced we performed well. Sales were $12.7 billion, a 4% decline compared with fiscal 2014. The entire decline in sales was driven by the effect of currency rate changes. Organic growth was flat as growth from most of our markets and innovative new products was offset by significant weakness in our natural resource-related end markets. We delivered a 50 basis point improvement in adjusted operating segment margins despite this sales decline and reached 14.9% compared to 14.4% in fiscal 2014. Fiscal year 2015 earnings per share were $6.97 compared to $6.87 in the prior year. On an adjusted basis earnings per share were $7.25 compared to $6.94 in fiscal 2014. As a reminder, fiscal 2015 earnings included $0.38 per share in transaction currency gains that are not expected to repeat in fiscal 2016. Cash flow was strong with full-year cash from operations of $1.3 billion or 10.2% of sales. This is the 14th consecutive year of cash sales greater than 10%, excluding discretionary pension contributions. This is strong, consistent performance despite several downturns over that timeframe. Our capital allocation priorities remain the same. Our top priority is to maintain our dividend and increase record followed by investing in our organic growth through CapEx and innovation. We remain committed to executing our previously announced share repurchase program while concurrently evaluating strategic acquisitions to boost the company's growth and profitability. We have repurchased approximately $1.3 billion under our plan to purchase $2 billion to $3 billion worth of Parker shares over two years which began in October 2014. Our efforts to re-energize the pipeline of acquisition opportunities are proving effective as we're starting to see a pickup in activity. Moving on to a discussion on key market trends. We saw continued weak conditions in some key markets that are important to our business. Specifically, natural resource markets like oil and gas, agriculture, mining, and construction equipment showed continued weakness. Our distribution channel was also affected, especially those distributors who are exposed to oil and gas. These difficult market conditions outweighed positive growth trends in other markets such as power generation, heavy-duty truck, automotive and commercial residential air-conditioning. For fiscal year 2016, we are initiating guidance for earnings per share of $6.15 to $6.85 or $6.65 to $7.35 per share on an adjusted basis. This guidance includes an increase in adjusted segmented operating margins of 14.9% to 15.4% for FY '16. Guidance for fiscal 2016 includes business realignment of approximately $0.50 per share, of which $0.30 per share relates to our simplification initiatives. Simplification is one element of a broader effort to reduce complexity, increase speed, reduce costs and better serve our customers. Many of our groups have announced plans to consolidate divisions and eliminate the associated redundant overhead costs. Organization and process design changes are being implemented to streamline operations and corporate functions. We're also removing bureaucracy that can get in the way of our team members taking action to meet the needs of our customers. Simplification initiatives like these, when combined with our traditional realignment actions to optimize our manufacturing footprint, will build a stronger, more agile Parker capable of generating consistent long-term profit growth. We do anticipate a bottom forming in fiscal year 2016 with the first half expected to continue with challenging conditions and the second half showing a slight uptick. Overall we forecast sales for the year to be down slightly. We will continue to aggressively manage costs in this environment while still investing in growth initiatives such as innovation. The cost reductions that were put in place in fiscal 2015 and the planned actions for fiscal 2016 will help us perform better in tough conditions and strongly position the company for the future. While adjusting our businesses to meet our immediate challenges we continue to plan for the future. On September 22 during our Investor Day in New York, we will share more details about a comprehensive refresh of the Win Strategy. We have spent the past six months gathering input from our key stakeholders globally. While many of the principles of the Win Strategy remain relevant, we're making changes that are intended to take the company's performance to the next level. Our target will be to achieve top quartile financial performance among our Diversified Industrial peers and we see many specific opportunities to drive growth and margin expansion at Parker. We're excited about these opportunities that will position Parker to be an even stronger leader as the number one motion control company in the world. And for now, I will hand things back to Jon to give you some more details on the quarter.

Thanks, Tom. Transitioning to slide number 6, I will discuss the earnings per share for the quarter. Adjusted earnings per share for Q4 was $1.43 compared to $2.06 for the same quarter last year, reflecting a decrease of $0.63. This amount excludes restructuring and voluntary retirement expenses of $0.16 and compares to $0.08 for the same quarter in the prior year. Additionally, in Q4, we made several tax adjustments amounting to $0.30 per share due to the mix of pretax profits noted this quarter, along with a few discrete items incurred. For the full year 2015, adjusted earnings per share were $7.25, up from $6.94 in 2014. Total realignment expenses for 2015 were $0.28, compared to adjustments for restructuring, asset write-downs, and the formation of a joint venture which totaled $0.07 in 2014. Also in FY '15 earnings, we included $0.38 per share in transactional currency gains that are not expected to occur in FY '16, as Tom mentioned earlier. On slide 7, we analyzed the factors influencing adjusted earnings for Q4 compared to last year's Q4. You'll see the key components explaining the decrease from adjusted earnings of $2.06 to $1.43 for Q4 FY '15. The fewer shares outstanding contributed an increase of $0.10 per share. Reductions to adjusted per share income included lower adjusted segment operating income of $0.30 per share, driven by a stronger U.S. dollar and weaker market demand; the impact of a higher effective tax rate amounted to $0.30 per share due to changes in the geographic mix of pretax profit as well as discrete items; and an increase in corporate G&A expenses, totaling $0.13 per share, partly due to the early retirement program in FY '15 and one-time credits in FY '14 Q4. Slide 8 discusses the influences on adjusted earnings per share for 2015 versus 2014 for the complete year. Here, you'll see how adjusted EPS increased from $6.94 for 2014 to $7.25 for 2015. An increase of $0.59 came from net other income, including $0.38 related to the transactional currency gain mainly recorded in Q3 FY '15; also lower stock compensation expense in FY '15 of $0.07 and reduced pension expense of $0.05 compared to FY '14. There was a further $0.30 from fewer shares outstanding due to the company's enhanced share buyback program initiated in October 2014. Decreases in earnings were driven by a decrease of $0.33 primarily due to corporate G&A, $0.23 from a higher effective tax rate, and a $0.02 reduction in adjusted segment operating income. Now moving to slide 9, we will review total company sales and segment operating margins for both the fourth quarter and the full year. From a segment perspective, total company organic sales in Q4 fell by 4.9% compared to the same quarter last year, with minimal sales contribution from acquisitions. The currency impact was slightly higher than expected, resulting in a negative effect on reported sales of $210 million or $0.06 this quarter. The total segment operating margin for Q4, adjusted for realignment costs, was 14.9% compared to 15% for the previous year’s quarter. Restructuring costs in the quarter were $27 million compared to $18 million last year. The decline in adjusted segment operating income this quarter was $467 million versus $530 million last year, impacted significantly by a stronger U.S. dollar against foreign currencies. For the full year, organic sales in FY '15 adjusted for the GE joint venture showed a slight increase of 0.6%. Foreign currency translation had a negative effect on reported sales of $546 million, equating to a 4.1% decline for the full year that entirely represents the sales decline in FY '15. The total company segment operating margin for FY '15, adjusted for realignment costs, was 14.9%, recovering from 14.4% in FY '14, marking a 50 basis points increase. Restructuring and voluntary retirement expenses for FY '15 totalled $50 million. On slide 10, we will discuss the actual business segments within Diversified Industrial North America. For Q4, North America organic sales decreased by 6% compared to the same quarter last year, and the quarter faced a 1.2% negative currency impact. The operating margin for Q4, adjusted for realignment costs, stood at 17.3%, down from 17.7% the previous year. Restructuring and voluntary retirement expenses totaled $15 million, up from $1 million in the prior year, with adjusted operating income reported at $244 million compared to $269 million last year, reflecting the reduced volume due to weakening trends in key end markets. For the full year, organic sales for FY '15 showed a 1.2% increase, with minimal sales contributions from acquisitions. Foreign currency translation negatively impacted reported sales by $50 million or 0.9%. The 2015 full-year operating margin, adjusted for realignment costs, was 17% of sales, compared to 16.7% in the previous year. Restructuring and voluntary retirement expenses tallied $17 million compared to $2 million in FY '14, with adjusted operating income at $972 million in FY '15, slightly up from $949 million last year. Continuing to slide 11, organic sales for the quarter within the Diversified Industrial international segment fell by 4%. Currency issues negatively affected sales by 13.6%. For Q4, the operating margin adjusted for realignment costs was 10.9% of sales, down from 11.2% the prior year. Restructuring expenses for the quarter totaled $6 million compared to $18 million last year, with adjusted operating income at $124 million falling from $156 million, reflecting the effects of a strong U.S. dollar and weaker end markets. For the complete year, organic sales in FY '15 declined by 1.2%, with foreign currency translating into a reported sales decline of $487 million or 9.2%. The FY '15 operating margin, adjusted for realignment costs, showed a slight increase to 12.9% of sales from 12.7% in the prior year. Restructuring expenses were $27 million compared to $99 million in FY '14, while adjusted operating income for FY '15 was $611 million, down from $671 million last year, influenced by the stronger U.S. dollar. On slide 12, in Aerospace, organic revenues decreased by 4% this quarter, with currency posing a minor negative impact of 0.6%. Strong commercial OEM sales were recorded, but the segment's sales decline stemmed from lower military OEM and aftermarket sales volume, as well as favorable contract settlements from FY '14 Q4. For Q4, the operating margin, adjusted for realignment costs, was 16.9% of sales compared to 17% in the prior year. Restructuring and voluntary retirement expenses incurred this quarter amounted to $5.8 million against no related expense in the comparable prior year quarter. The adjusted operating income was $99 million compared to $105 million from last year, reflecting the downturn in aftermarket sales volume but partially offset by reduced development costs, which represented 7.5% of sales for the quarter. For the full year, organic sales for FY '15 rose by 3.7% after adjusting for the impact of the joint venture. The FY '15 operating margin, adjusted for realignment costs, reached 13.5% compared to 12.5% in the previous year. Restructuring and voluntary retirement expenses totaled $6 million compared to $1 million last year, with adjusted operating income for FY '15 reported at $305 million, up from $272 million the previous year, primarily due to lower development costs relative to sales and increased OEM commercial volume. Moving to slide 13, we offer details on orders changes by segment. Remember, we report orders on a trailing average expressed as a percentage increase in absolute dollars year over year, excluding acquisitions, divestitures, and currency. The Diversified Industrial segments report on a three-month rolling average, while Aerospace Systems use a 12-month rolling average. Total orders saw a decline of 9% for the quarter, reflecting continued weakness in the oil and gas, construction, mining, and agriculture sectors, which are key industrial markets. Diversified Industrial North America orders dropped to negative 9%; International orders decreased by negative 5%; and Aerospace orders saw a negative change of 14% for the quarter compared to notably high prior year values. Moving to slide 14, we will discuss cash from operations. In the fourth quarter, cash from operating activities reached $511 million, representing 16.2% of sales, consistent with the same percentage from the prior year. For the entire year, cash from operating activities for fiscal 2015 amounted to $1.3 billion, or 10.2% of sales, compared to 11.1% from the previous year. In FY '14, cash from operating activities was adjusted for a $75 million pension contribution, which did not occur in FY '15. Significant cash uses included $1.7 billion returned to shareholders through $1.4 billion in share repurchases and $340 million in dividends, alongside $216 million for capital expenditures amounting to 1.7% of sales for the year. Now, turning to the guidance on slide number 15, guidance is provided on an adjusted basis. Segment operating margins and earnings per share exclude expected business realignment charges forecasted for FY '16. We expect total sales to range from a decline of 3% to flat compared to the prior year. Adjusted organic growth at the midpoint is close to flat. Currency is anticipated to negatively impact sales by 1.7%, primarily impacting the industrial international segment. We have calculated the currency impact based on spot rates as of June 30, 2015, maintaining these rates for the upcoming FY '16. Total Parker's adjusted segment operating margins are forecasted to be between 15.2% and 15.6%, which compares to 14.9% for 2015 on an adjusted basis. Guidance for below-the-line items, which includes corporate administrative costs, interest, and other expenses is set at $540 million for the year at the midpoint. The full-year tax rate is projected to be 29%. The average number of fully diluted shares outstanding used in our full-year guidance stands at $140.8 million. Regarding share repurchase, as indicated during last quarter's earnings call, we are committed to the $2 billion to $3 billion share repurchase program announced in October 2014. As of now, our repurchase spend totals 67% of the low end of the announced program, and we expect to complete the remaining repurchases within the next 14 months. For full-year guidance on an adjusted earnings per share basis, it is projected to be between $6.65 and $7.35, or $7.00 at the midpoint. This excludes around $100 million in business realignment expenses anticipated in FY '16. The restructuring's effect on EPS is about $0.50 for the full year, comprising $0.20 for restructuring and $0.30 for the simplification initiatives outlined by Tom earlier. We forecast savings of $70 million from these business realignment initiatives. Some additional key assumptions for full-year 2016 guidance include sales being split 48% in the first half and 52% in the second half; adjusted segment operating income divided 45% for the first half and 55% for the second half; with EPS for the first half estimated at $2.96 and $4.04 for the second half. The Q1 adjusted earnings per share is anticipated to be $1.47 at the midpoint, excluding $0.21 attributed to business realignment expenses, including both the simplification program and traditional restructuring. On slide 16, we have a major reconciliation of the main components of FY '16 adjusted EPS guidance set at $7.00 at the midpoint, reflecting a decrease from FY '15 EPS of $7.25 per share. Increases include $0.21 from fewer shares outstanding, $0.19 from increased segment operating income, $0.09 from lowered corporate G&A, and $0.02 from a reduced full-year effective tax rate. Key components of the decrease consist of a $0.68 reduction from increased other expenses due to prior year other income, with the largest portion stemming from the unpegging of the Swiss franc and the euro during the third quarter, leading to a one-time intercompany settlement gain in Q3 accounting for $0.38. This category is also impacted by a $0.19 increase in forecasted pension expenses due to updated mortality tables, and $0.08 in heightened interest expenses. Please remember that the forecast does not include any acquisitions or divestitures that were finalized or will be finalized during FY '16. For consistency, we request that you exclude restructuring expenses from your published estimates. This wraps up my prepared comments. Tom, I'll hand the call back to you for your closing thoughts.

Thanks, Jon. We do have some challenges ahead, but the good news about FY '16 is that with every quarter we move closer to the bottom of the decline in the natural resource markets that we serve. As we've demonstrated, we performed well in tough times. The bright spot is that we enter our new fiscal year leaner than ever and we're taking additional concrete actions to further lower our cost structure. We're also encouraged by our new product and systems commercialization progress. As a result, we expect to perform well as sales start to increase. Importantly, Parker has a fantastic foundation and legacy to build upon. Our culture is strong, with tremendous support by our global team members who I know will do everything they can to achieve the goals we have set for them. I want to thank them for embracing the changes that we're implementing at Parker. I'm confident we have a bright future ahead of us and I look forward to sharing with all of you our progress throughout the year. And with that I will turn it over to Mark to initiate the question-and-answer portion of the call.

I have a couple of quick questions. First, regarding the restructuring and simplification initiatives, you mentioned that you expect a $70 million payoff. Can you provide more details on which segments this restructuring and simplification is targeting? Additionally, when do you anticipate realizing the $70 million in savings? That would be my first question. My second question pertains to guidance. You indicated that you expect sales to increase in the second half of 2016. Can you elaborate on that? What gives you confidence that we will see improvement during the latter half of the year? Are you expecting easier comparisons, or do you believe the markets will improve? Any insights on this would be appreciated. Thank you.

Okay, Jamie, I'll begin. This is Tom. You have two questions. I'll address the restructuring simplification first. Jon will provide more details, and then I'll respond to your question about the guidance. We're introducing a new concept of simplification, which isn't entirely new to the company. The goal is to reduce complexity, increase speed, lower costs, and improve customer service, ultimately supporting growth. Key areas of focus include examining our revenue profile, especially the last few percentages of revenue, which often come with excessive costs, part numbers, and quote activity. We're also looking at simplifying our organization and processes to align with that revenue profile, as well as reassessing the number of layers and spans of control within our organizational structure. We believe in our divisional structure with a strong profit and loss focus and will remain a decentralized company. Currently, we have 115 operating divisions worldwide. Upon review, we identified that about 20% have overlapping product charters or technologies that could benefit from consolidation to achieve greater scale and synergies in both growth and cost. As a result, we anticipate reducing about 10% of our operating divisions due to this overlap. Lastly, we aim to minimize bureaucracy, including reports and activities in our planning process, making how we operate simpler. I’ll let Jon share insights on the timeline for implementing these changes. The traditional restructuring involves workforce reduction, plant consolidations, and market adjustments, which will complement our simplification efforts. Jon, please provide some comments on the timing.

I think, Jamie, just in the big picture, 60% of the cost should be incurred in the first half. And we should get about 20% of the savings in the first half and then we will get to the remainder of the savings in the second half. And of course, the 40% of the cost incurred in the second half. So that is the way we have kind of got it timed in our guidance. We have got very detailed plans and we're going to leave it at that for now.

Jamie, regarding your second question about how we established our guidance, this process is a bottoms-up approach from our divisions. We create economic models to project potential forecasts, and these models align closely on the guidance we provided. For the first half of the year, we are still encountering challenges in natural resource-related markets, such as oil and gas, agriculture, mining, and construction. We anticipate that distributors, particularly those linked to oil and gas, will continue to destock in the first six months. We foresee agriculture and mining beginning to stabilize by the end of this calendar year, which coincides with the end of our second quarter. Our forecast indicates that oil and gas and construction equipment will also reach their lowest point by the end of our fiscal year. Although we do not expect any immediate improvement from construction and oil and gas, the fact that these markets are not declining as quickly and are nearing their lowest point by year-end presents a more manageable environment for us. The natural resource markets are likely to be at or close to their bottom. On a positive note, other markets that have shown growth this year are expected to continue their upward trend into next year, contributing to growth in the second half. We will benefit from easier comparisons and will be stabilizing in the more challenging markets, while growth areas will include power generation, heavy-duty trucks, rail, semiconductors, life sciences, general industrial, automotive, telecom, air conditioning, and aerospace. We anticipate modest growth for distribution. This summarizes our expectations for the year and explains how we arrived at the minus 1.5 guidance for the entire year.

Tom, just to clarify your last comment, are you anticipating some growth in distribution compared to original equipment globally? And could you provide more details about the recently completed quarter, specifically regarding the order decline and how the distribution versus original equipment mix played out?

Yes, I will start and I'm going to let Lee cover the market for the last quarter. But yes, our assumption is that there will be a small moderate growth, low single digits, for distribution in our forecast period. But I will let Lee give you color on the current quarter, what we saw, what we're currently seeing.

Timothy, this is Lee. I'll discuss the industrial markets and walk you through the different regions, touching on distribution and original equipment across those areas. I see three primary headwinds: the translational effect of currency on revenue, the impact of natural resource-driven markets, and ongoing regional weaknesses particularly in Europe, China, and Brazil. Starting with North America, distribution grew organically in FY '15, but we noted a slowdown in Q3 and a contraction in Q4, impacting year-over-year comparisons. This slowdown is primarily linked to distributors heavily involved in oil and gas. We anticipate another six months of destocking in that channel. On a positive note, we're seeing strong growth with our distribution base related to automotive Tier 1s and machine builders. In oil and gas, we are experiencing a contraction across all upstream sectors, with offshore activity worsening since our last update. Land-based activities have also seen a mild decline, but not as steep as Q3. On a positive note, we're improving our market position by helping customers lower costs and have made advancements in technology that position us favorably moving forward. In agriculture, we acknowledge the softness, while power generation has been performing well globally, particularly in North America. The shift from coal to gas-fired plants has opened opportunities for us, and our energy storage business is gaining momentum, especially with new contracts in that area. In the heavy truck market, Class 8 builds remain strong, and we continue to experience growth with our products and subsystems, aided by new technologies for emissions controls. However, we see softness in mobile markets, particularly mining and construction equipment, but we are optimistic about recent ABI trends. Turning to Europe, there's been much talk about potential recovery, but we've not seen significant improvement from our customers, with some exceptions. Export activity from Germany has slowed, likely due to decreased demand from China. Oil and gas activities continue to lag, with delays in major capital projects. Distribution performance has been mixed, generally flat to slightly declined, while there have been modest gains in construction. Agriculture remains soft due to low food prices and ongoing debates over subsidies, combined with geopolitical issues impacting investments. The truck market in Europe had a strong quarter, particularly driven by pre-purchased Euro 5 trucks, and we expect future demand to align more closely with actual needs. In China, we saw slight improvement in Q4, yet construction machinery remains weak. Distribution in Asia is experiencing growth due to better same-store sales and expansion of locations. Both rail components and automotive plants in the region are performing well, with positive developments in renewable energy. Lastly, in Latin America, particularly Brazil, there is significant GDP contraction across sectors except for power generation, where we have notable successes in solar and wind projects. Although heavy-duty trucks and natural resources are weak, we are benefitting from Petrobras reducing their investment plans significantly, allowing us to focus on maintaining existing infrastructure. This overview captures our observations for the quarter.

If I could just get back to the margin guidance for 2016, can you talk about your total Parker margin guidance is up about 50 basis points despite lower revenue. I am sure you get some benefit from the new simplification project that you are embarking on. Can you talk about where the underlying margin improvement is coming from, be it restructuring or new products, etc.?

Nathan, the improvements are coming from several areas. We've undergone restructuring this year, including an early retirement program in the fourth quarter and a significant restructuring in fiscal year 2014. We're pleased with those changes, as they will continue to provide savings for us in fiscal year 2016. The simplification program we're launching in fiscal year 2016 will also help enhance our margins. Overall, we're focused on increasing our margins, and as a result, we've managed to achieve adjusted margins that are 50 basis points higher in fiscal year 2016, despite a decline in reported sales. This improvement is largely due to a reduction in our fixed cost infrastructure as well as our efforts to boost new businesses and products, which we expect to yield higher margins in unprecedented ways. When we put everything together, it gives us a competitive edge. Additionally, we're observing a 100 basis points increase in margins in Aerospace, which is contributing to the overall margin growth for the company next year. A significant portion of the enhanced margins in Aerospace is attributed to lower development expenses and the growth we're seeing in OEM commercial shipments during the super cycle.

And then my follow-up question is on pricing. You have seen 4% order declines in the third quarter, 9% order declines in the fourth quarter. Can you talk about what impact that is having on pricing in the market and how competitors are behaving, what the competitive environment is like at the moment?

I mean certainly it is a tough pricing environment. I mean we're pleased but we track this very closely with our SPI index and we're still positive year to date; we were positive in the quarter. One of the things that we try to do is really address our customers' cost issue. And we do that through bundling technologies and helping them take cost out of their system. So we try to get away from price per se. But the bottom line is still positive; it is a tough environment, though I don't want to describe it any other way.

Are you expecting price to be neutral to positive going forward?

We're expecting it basically to be flat in our guidance.

Can you provide more details about your Aerospace orders? I might have missed it, but you mentioned challenging comparisons, and I believe you also indicated that the commercial aftermarket was down. You're not the only company pointing this out, so I'm curious about what's happening in the commercial aftermarket or if I overlooked something.

Not sure. Well, I think that in our commercial aftermarket we're actually up slightly there in our orders. So it is not a big move up, but we're up slightly there. From an order standpoint the major driver for us is military. And so these orders, Ann, that are really driving our numbers, as you know, for the military can be very lumpy and that was the comparable number that I was talking about. And that is what is really driving the numbers. We're also seeing some move in our commercial OEM business down slightly. But again, that is from a very high ordering pattern this time last year and really throughout the beginning of the cycle which is now starting to level off to more numbers that are more representative of how we see ourselves going forward which is indicated in our guidance. Does that help, Ann?

Yes it does actually. Thank you, it helps a lot. I've got a lot of questions on that since you released. Can you talk about your confidence in your outlook for the start of a recovery and distribution in the back half. There isn't much visibility there; I mean where could you be wrong?

Ann, this is Tom. I mean, as you know, any forecast is usually wrong the day after we send it out. But I think we have some fair assumptions. We have done this through visibility to customer demand, distribution inventory, our own economic modeling and then our bottoms-up from our divisions was all basically coalesced along the same thing. So the key assumptions will be that we're assuming bottoming of some of those end markets that were giving us the most trouble. So mining in the second quarter and Ag in the second quarter and then oil and gas and construction in Q4. So if those were to slip at all, that would be a potential risk. But that is our best assumption right now. And of course every quarter we're going to give you a new look at that and what we think. So we think that is fair based on all the intelligence that we have been able to gather to date. And then other than your oil and gas outlook, are you assuming an increase in rig count from here or just kind of stay at this level and we bump along? Yes, we're assuming flat and basically if oil and gas gets to flat that becomes a positive for us because it has been such a drag the last two quarters.

If we could just zero in on oil and gas, I think you have talked about that as being a $1 billion business. Can you just talk about how you think about that for the full year magnitude of decline and how that kind of plays into the margin mix?

Well, Jeff, this is Lee. We have discussed that there is a significant challenge regarding the margin mix. Our OEM customers in the oil and gas sector are down by 50%, and they are currently undergoing a considerable destocking process with us. Once we navigate through that and address the inventory present in the channel, demand should stabilize, which would be a positive development for us. However, aside from expecting some stabilization, we are not anticipating a significant bounce back in that market.

Yes, in the quarter about 4% would be our best guess. And I think a lot of that has to do with, again, just destocking some of these end markets.

I would like some clarification. Your guidance indicates a share count of 140.8, and I assume you have spent around $1.4 billion so far. Are we to understand that you will not be buying back stock significantly for the remainder of the year, or is this just not reflected in your guidance and we should consider the potential for more than $600 million?

Eli, it is Tom. We did not include it in our forecast, but you can be assured that we remain committed to the $2 billion to $3 billion share repurchase plan we communicated. We will buy back shares opportunistically, and you can expect to see us continue this going forward.

So, will go down if you do execute? Can we discuss your expectations for profitability in the Rest of World segment? You've indicated margins are expected to increase by 50 to 100 basis points, despite what seems like stagnant volume. Is this improvement related to the program you've announced this year? Additionally, we're trying to understand the $70 million benefit you mentioned—will it largely impact International, or is it divided among International, Rest of World, and North America?

Yes, Eli, Jon here. Overall the benefits of the program we're going to see worldwide. This is a business process simplification and it is going to have an impact on our margins worldwide. So I think we will see equal implications for North America as we will for our Industrial International businesses there.

And is that the source of the improved margins in Rest of World or is there something else happening?

It is one of the key factors for our improved margins. But we're continuing to look as our market starts to stabilize to be able to generate a margin in Europe much higher than we have been experiencing here in FY '15 and so we've been, as you know, determined to do that for the last couple years. And we start to see improvement in our European margins as all of the simplification and all of the prior restructuring take hold in our cost structure there. And so, we will see it in Europe; we will also see improvements in our Asian businesses too. But I don't want to give you the impression that this is 100% of the driven increases in our margins. This also has a lot to do with our Win Strategy, our ability to do pricing right, to do buying right, to recover from some of the translational and transactional impacts of currency headwinds that we're feeling in some of the countries in Europe. And so, there is a whole host of activities that we're working on very hard here to help drive our margins.

A couple questions, the first one is kind of asking something that has been asked a couple times before at least in a different way. Can you help us understand what sort of benefit from internal restructuring realignment and early retirement initiatives are included in the $0.19 operating profit increase shown on slide 16?

Okay, let me just make sure that I am tracking there with you. Yes, well, listen, in that $0.19 it has got all of the impact of the simplification. Keep in mind that our revenues are going down. So we're showing increased operating earnings on lower as reported earnings. And part of the driving force for us to be able to increase our earnings in a lower sales environment, which I realize is at first glance completely counterintuitive, is our ability to do the simplification program the way that we have outlined it, as well as reap the benefits from the prior restructuring that we have done, the early retirement that we have done here in that fourth quarter of this year. And that is the source of the $0.19. And again, just to remind you, I know you know this very well Andy, but this is a compilation of all of the programs from a bottoms up perspective in the company. And this is not just one program, we're making it sound like it is one program and it is externally. But inside this is many, many, many programs at the divisional in group level within the company and this is how it gets rolled up here in the company when we actually ended up doing our guidance. And that is a big basis for the $0.19 that we're showing on that slide. So, I don't want to give you the impression that this is just a big tops down look at the forecast for FY '16. This is something that has come up from the divisions like we normally do. And this is the result of that process as we start to review it and make adjustments to our operating cadence around the world.

If you ex out the initiatives that have yet to be done, some of the initiatives you announced today.

Yes.

What sort of benefit is just carryover from what has already been done?

Well, we have got a $50 million carryover from the effort that we had put together here in FY '15. And that's really the benefit that we're going to see next year and that will be bleeding right into the cost structure in FY '16. So that is one number that we're very firm about, we feel we have a lot of confidence in and that is the number that is rolled up into the forecast that we're getting from the team.

And then in the first half/second half outlook, I just want to make sure if there are any items on top of the revenue outlook by market that you kind of gave. Does the first half outlook include any inventory reduction actions, either on the corporate level or in your distribution channel, that when you look into the second half to expect that to normalize?

As I mentioned earlier, for the first six months we're assuming some destocking in our distribution channel. So that is part of the headwind we will have in the first half of the year from a revenue standpoint.

And then one last one if I could fit it in on the Aerospace back to, I think it was Ann's question. Some other participants have described some distribution channel choppiness. Are you seeing any of that at this point? It doesn't sound like your order intake is suggesting that on the commercial side.

No, we're really not, Andy. We have not a booming commercial aftermarket, but we have steady commercial aftermarket experience here in our FY '15 and that is what we're expecting here for FY '16. Now from quarter to quarter of course there can be some issues, but we didn't experience in Q4 and we're not planning on anything unusual other than the normal seasonal patterns that we will see in FY '16 as we saw in FY '15.

Jon, you mentioned the $50 million carry-forward from, I guess, your 2015 initiatives into 2016 and you also mentioned $70 million. Does the $70 million map to the $100 million of charges you are taking? So that would imply, based on what you said, $14 million or 20% savings in the first half and $56 million or the remainder 80% in the second half? So basically we're looking at an incremental $120 million with that split out? Is that the benefit for 2016, is that the way to think about it?

I think you are right, Jon. I am going to have to take a look at my numbers here right now. We have got savings of $24 million that are related to the $100 million in the first half. And we have got a savings of $46 million in the second half related to the backend of a $70 million of the $100 million cost. So the total cost for the program in FY '16 is $100 million, the total savings in FY '16 is $70 million. So there is a total net cost of $30 million which equates to $0.15. That $0.15 is built into our guidance.

But the total restructuring benefit, excluding the cost of $120 million, is related to the $50 million you mentioned.

That is correct.

Okay. And then you were kind enough to give us your first half/second half assumptions. What would be your organic growth assumptions, Jon, first half versus second half? Is there any way to provide a little color there? To get to Tom's point about flat for the year?

Yes, I'm going to just give you a rough order of magnitude on the organic growth in the second half of FY '16 as part of our guidance is about 2.5% organic growth on, of course, much different comps that we're talking about right now at that time that we're projecting for our FY '16 Q3 and Q4.

With a little bit of recovery excluding comps baked into that I am assuming based on all of the commentary you've made in this call. Is that fair?

That is correct. This aligns with the comments we heard from Tom and Lee about our gradual but sequential improvement starting in the second half, which is very slow and very modest.

Can I follow up on the $100 million? You've faced challenges in Europe for several years, and while you weren't alone in this, you made significant restructuring moves in 2014. Now, as we approach 2016, there's another $100 million related to Europe. My question is, out of that $100 million, how much will be structural versus variable? Is it a reduction in force due to weak markets? Also, what specific actions are you taking in Europe now that you didn't implement in 2014 and 2015? I'm trying to grasp the situation better.

Sure.

So, John, this is Tom. There is a difference between what we did before. Before we focused on footprint optimization and classic plant consolidations and those type of things. The simplification initiatives which is, as you know, 60% of the total restructuring cost, is focused more on organization and process optimization looking at revenue complexity. And that is global, it is not picking on Europe. This is 50-50, we're going to have half of these actions in North America and half internationally. And that half international will cover Latin America, Asia-Pacific and Europe because these processes are issues around the world. And we're just taking a fresh look at it around revenue complexity, organizational complexity, division consolidations and bureaucracy. And I can tell you right now this has got a lot of energy behind it, a lot of enthusiasm. It is not easy and it is tough decisions, but there is a lot of interest because when you do these things right you are going to be faster to serve customers and it is going to enable growth for the company.

It sounds like this may be related to your own transition as CEO, aiming for a refresh of Win rather than addressing any specific issues from the quarter. I assume much of this, you could consider strategic, is that accurate? Or is there a balance based on the challenging short cycle economy we're currently facing?

Well, John, I think you nailed it. This is something that both Lee and I and Jon have discussed, knowing when the succession was going to happen, that this was something strategically we wanted to consider. This involves two parts: we're going to carry out the usual adjustments to the market that we’ve always done, including classic restructuring and realignment. Additionally, we are implementing strategic initiatives that will lead to a more efficient cost structure and an improved service model for our customers. This is just one aspect of the refreshed Win Strategy. Everyone on the call will have the opportunity to hear more details. We have referred to this as the simplification piece because it plays a significant role in this year’s operating plan. However, there are many other topics we want to discuss related to growing the company in line with the market and expanding margins, which we will provide more insight on during our Investor Relations day in September.

Okay, well, thanks, John. And this concludes our Q&A and our earnings call for today. Thank you to everybody for joining us. Robin will be available throughout the day to take your calls should you have any further questions. Thank you and have a great day.