Parker-Hannifin Corp (PH) — Q1 2017 Earnings Call Transcript

Thank you, Andrea. Good morning, and welcome to Parker-Hannifin's first quarter FY '17 earnings release teleconference. Joining me today is Chairman and Chief Executive Officer, Tom Williams, and President and Chief Operating Officer, Lee Banks. Today's presentation slides, together with the audio webcast replay, will be accessible on the company's Investor Information website at phstock.com for one year following today's call. On Slide 2, you'll find the company's Safe Harbor disclosure statement addressing forward-looking statements, as well as our non-GAAP financial measures. Reconciliations for any references to non-GAAP financial measures are included in this morning's press release and are posted on Parker's website at phstock.com. Turning to Slide 3, today's agenda is outlined. To begin, our Chairman and Chief Executive Officer, Tom Williams will provide highlights for the first quarter of fiscal year '17. Following Tom's comments, I'll provide a review of the company's first quarter FY '17 performance together with guidance for FY '17. Tom will then provide a few summary comments, and then we'll open the call for a Question & Answer session. At this time, I'll turn it over to Tom and ask that you refer to Slide 4.

Thanks, Jon, and welcome to everyone on the call. We appreciate your participation this morning. Today, I'd like to share highlights of our first quarter results, comment on our fiscal year 2017 guidance, and finally share progress we are making with the new Win Strategy. Before I discuss the financial highlights of the quarter, first, I’d like to talk about safety. Keeping people safe is our first priority, and as such, we start our meetings at Parker with a discussion on safety. So I thought I’d start our earnings call with safety as well. During the first quarter of 2017, we were able to reduce our recordable injuries by 35% compared to the prior year. This builds upon a 33% year-over-year improvement we posted comparing 2016 versus 2015. We have a long way to go to reach our goal of zero accidents, but I’m very pleased with the progress we’re making. Safety is important because it protects our people, but also great safety performance typically leads to great financial performance. Now to the financial highlights of our first quarter results. First quarter sales were $2.74 billion, a 4% decline compared with the same quarter a year ago. This represents the third consecutive quarter we saw a decelerating rate of decline in sales on a year-over-year basis. Nearly all the decline in sales this quarter was organic. Total order rates in the first quarter increased 2% compared with the same last year on easier comparisons. This represented the first quarterly increase in orders since December 2014. By segment, North America is still weak but slowly recovering, and our aerospace systems segment and international business order rates were positive. These order rates reinforced our previously communicated view that we’re progressing towards stabilization in many of our key markets. However, we will continue to monitor order trends closely to ensure that this outlook is holding up. Net income for the first quarter increased 8% to $201 million on an as-reported basis or $218 million on an adjusted basis. Earnings per share were $1.55 as reported or $1.61 on an adjusted basis. A 6% increase in adjusted earnings per share compared with the same quarter last year. Despite soft market conditions, we were able to achieve total segment operating margins of 15.0% or 15.4% adjusted. This is another quarter of solid performance and represents a 10 basis point improvement year-over-year in the adjusted segment operating margins. Our decremented margin return on sales or MROS was 3.9% for the first quarter or 12.7% on an adjusted basis. This is really outstanding performance and marks the seventh consecutive quarter that our adjusted decremented have been below 30%. It was another strong quarter for cash flow; cash flow from operations, excluding a discretionary pension contribution, was 12% of sales, reflecting our ability to be a consistent generator of cash through economic cycles. During the quarter, we've repurchased $115 million in Parker's stock, completing the previously announced commitment to buy back a minimum of $2 billion in Parker’s shares as of October 2016. Going forward, our plan is to be a great generator of cash and a great deployer of cash in a way that generates increased long-term returns for our shareholders. Now regarding FY17 guidance, we continue to forecast a year of flat sales compared with 2016. For 2017, we are maintaining guidance for as-reported earnings in the range of $6.15 to $6.85 per share or $6.50 at the midpoint. On an adjusted basis, we expect earnings per share in the range of $6.40 to $7.10, or a midpoint at $6.75. Business realignment expenses are still anticipated to be approximately $0.25 per share in fiscal 2017. So now just a few comments about our progress with the Win Strategy. We will continue to make meaningful progress across initiatives across four broad goals: engaging people, premier customer experience, profitable growth, and financial performance. Our ongoing execution with the new Win Strategy through its first full year implementation gives me even more confidence that we can achieve our key financial objectives by the end of fiscal 2020, which includes targeted sales growth of our 150 basis points higher than the rate of global industrial products. We’re also targeting 17% segment operating margins, and progress towards these goals is expected to drive a compounding growth rate in earnings per share of 8% over this 5-year period. These performance targets will allow us to deliver sustainable, long-term value for Parker team members, our customers, and our shareholders. I’ll now hand things back to Jon to review more details on the quarter and fiscal 2017 guidance.

Thanks, Tom. And at this time please refer to Slide 5. I'll begin by addressing earnings per share for the quarter. Adjusted earnings per share for the first quarter were $1.61 versus $1.52 for the same quarter a year ago. This equates to an increase of $0.09. This excludes business realignment expenses of $0.06, which compares to $0.11 for the same quarter last year. On Slide 6, we review the influences on the adjusted earnings per share for Q1 versus Q1 of FY '16. We had earnings per share of $1.52 for the first quarter FY '16 and $1.61 for the first quarter of this year. The increase to adjusted earnings per share includes a reduction of corporate G&A expense which totaled $0.11 per share, a lower effective tax rate of 28.1% versus 29.2% in Q1 of FY '16, lower interest expense, and the impact of fewer shares outstanding due to the company’s share repurchase activity, which equated to an increase of $0.07 per share. A reduction of $0.08 per share in income was a result of the lower adjusted segment operating income driven by weakened end market topline demand as projected while higher other expenses equated to a reduction of $0.01 per share. Moving to Slide 7, with the review of the total company sales and segment operating margin for the first quarter. Total company organic sales in the first quarter decreased by 4.6% over the same quarter last year. There was nominal contribution to sales in the quarter from acquisitions and minimal currency impact. Total company segment operating margins for the first quarter, adjusted for realignment costs incurred in the quarter, was 15.4% versus 15.3% for the same quarter last year. Business realignment costs incurred in the quarter were $11 million versus $22 million last year. The lower adjusted segment operating income this quarter of $422 million versus $438 million last year reflects the impact of the weakened industrial end markets, partially offset by the savings realized from the company's simplification and restructuring actions. Moving to Slide 8, I'll discuss the business segments, starting with Diversified Industrial North America. For the first quarter, North American organic sales decreased by 9% as compared to the same quarter last year. There was no impact from acquisitions and nominal impacts from currency in the quarter. Operating margin for the first quarter adjusted for realignment costs was 17.5% of sales versus 17.2% in the prior year. Business realignment expenses incurred totaled $4 million, as compared to $8 million in the prior year. Adjusted operating income was $205 million, as compared to $221 million, driven by the reduced volume as a result of those same key industrial end markets. I'll continue with the Diversified Industrial Segment on Slide 9. Organic sales for the first quarter in the industrial international segment decreased by 3.2%, with acquisitions positively impacting sales by 0.9%, while there was no impact from currency. Operating margins for the first quarter adjusted for business realignment costs was 14.2% of sales versus 13.6% in the prior year. Realignment expenses incurred in the quarter totaled $7 million as compared to $12 million in the prior year. Adjusted operating income was $144 million as compared to $141 million, which despite the weakened topline reflects the offsetting savings resulting from the realignment actions taken in the current and prior fiscal years. I’ll now move to Slide 10 to review the Aerospace System segment. Organic revenues increased 3.1% for the quarter, with neither acquisitions nor currency impacting revenues. Growth in military OEM, commercial OEM, and commercial aftermarket sales were the drivers for the quarterly performance as compared to the prior year. Operating margin for the first quarter adjusted for realignment costs was 13.1% of sales versus 13.9% in the prior year. No business realignment expenses were incurred in the quarter, compared to $2 million in the prior year. Adjusted operating income was $73 million as compared to $76 million reflecting the timing impact of higher development costs during the quarter. Moving to Slide 11 with the detail of orders changes by segment. As a reminder, Parker orders represent a trailing average and a percentage increase of absolute dollars year-over-year excluding acquisitions, divestitures, and currency. The diversified industrial segment reports on a three-month rolling average while aerospace systems are based on a 12-month rolling average. Total orders improved to positive 2% for the quarter ending reflecting easing year-ago comparisons and a decelerating rate of decline in key industrial end markets. Diversified industrial North America orders decreased year-over-year to negative four, diversified industrial international orders increased modestly year-over-year to a positive three, and Aerospace Systems orders increased year-over-year to a positive 14%. On Slide 12, we report cash flow from operations. For the first quarter, cash flow from operating activities was $114 million or 4.2% of sales, this compares to 0.7% of sales with the same period last year. When adjusted with the $220 million discretionary pension contribution we made in the quarter, cash flow from operating activities was 12.2% of sales. This compares to 7.7% of sales for the same period last year, adjusted for the $200 million discretionary pension contribution in May last year. The significant uses of cash during the quarter were the $220 million for the discretionary pension plan contribution, $150 million for the Company's repurchase of common shares, and $85 million for the payment of shareholder dividends. $33 million for CapEx, equating to 1.2% of sales for the quarter is also called out. Turning to Slide 13, the full-year earnings guidance for '17 is outlined. The guidance has been provided on both an as reported and an adjusted basis. Adjusted segment operating margins and earnings per share exclude expected business realignment charges of $48 million, which are forecasted to be incurred throughout FY17. This is the only item for which we are adjusting. Total sales are expected to be in the range of negative 1.5% to 2.1% as compared to the prior year. Organic growth at the midpoint is nearly flat, and acquisitions in the guidance are expected to positively impact sales by 8.4%. Currency in guidance is expected to have a modestly positive 0.3% impact on sales. We have calculated the impact of currency to spot rates as of September 30, 2016, and we have held those rates steady as we estimate the resulting year-over-year impact for the upcoming balance of FY17. For Total Parker, as reported segment operating margins are forecasted to be between 14.8% and 15.2%, while adjusted segment operating margins are forecasted to be between 15.2% and 15.6%. The guided midpoint on each range compares favorably to FY16 margins, 13.9% on an as reported basis and 14.8% on an adjusted basis in FY16. The guidance for below-the-line items, which includes corporate G&A interest and other expenses, is $478 million for the year at the midpoint. The full-year tax rate is projected at 28.5%, and the average number of fully diluted shares outstanding used in the full-year guidance is 135.5 million. For the full year, the guidance range on an as-reported earnings per share basis is $6.15 to $6.85 or $6.50 at the midpoint. On an adjusted earnings per share basis, the guidance range is $6.40 to $7.10 or $6.75 at the midpoint. This as-reported EPS guidance excludes business realignment expenses of approximately $48 million to be incurred in FY17. The effect of this restructuring on EPS is approximately $0.25. Savings from these business realignment initiatives are projected to be $30 million and are fully reflected in both the as-reported and the adjusted operating margin guidance ranges. 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 fiscal year 2017 guidance are sales divided 48% first half, 52% second half. Adjusted segment operating income is divided 45% first half, 55% second half. EPS first half is $2.96 and $3.79 at the midpoint, that’s first half versus second half. And Q2 adjusted earnings per share is projected to be $1.36 per share at the midpoint and this excludes $0.10 of business realignment expenses expected to be incurred in our Q2. On Slide 14, you'll find a reconciliation of the major components of FY17 adjusted EPS guidance of $6.75 per share at the midpoint from the prior FY17 EPS of $6.75 per share. Increases include $0.05 from lower corporate G&A and $0.05 from the lower tax rate. The key component of the decrease includes a $0.10 per share reduction from higher other and interest expense. Please remember that this forecast excludes any acquisitions and divestitures that might close during FY17. This concludes my prepared comments. Tom, I’ll turn the call back over to you for our summary comments.

Thanks, Jon. I’m glad we’ve started 2017 on such a positive note. I would like to thank the appropriate team members around the world for their efforts. Not only have we made meaningful progress with initiatives designed to improve margins, but we’ve also taken great strides to strengthen and sustain our business and better serve our customers. We’re positioned well for the rest of this year and beyond under the framework provided by the Win Strategy. I look forward to sharing more with you, as always, as the progress continues. And at this time, we are ready to take questions. So Andrew, if you could help to get started.

I think I would like to talk a little bit about cash generation and cash usage today. Very, very strong cash flow quarter in what I don't think is normally an overly strong cash flow quarter. I think for as long as I have followed Parker, your target has been 10% of sales converted into free cash flow. Is the new Win Strategy executing that structurally changing that target, and should we think about cash generation being some number higher than 10 going forward?

Nathan, this is Tom. 10% has been our historical target; it’s still the target. What we’ve done as far as determining that target is see what’s top quartile against our peer group. When we set that goal years ago, 10% was top quartile, and as we benchmark it today, 10% is still top quartile. As we continue to raise margins, which is our goal, we should continue to perform even better, but the goal is to be top quartile. We happen to be a pretty consistent performer in being top quartile on cash, and I think you can expect us to continue doing that.

Okay, fair enough. And then the $2 billion share repurchase is complete. The commitment that Don made a couple of years ago there is complete. The balance sheet is still pretty robust; you've still got plenty of capacity there. How should we think about your approach to M&A versus share repurchase going forward from here?

Hey, Nathan, it’s Tom again. We look at both of those all the time on a dynamic basis with the goal of making the best long-term value creation decision for our shareholders. I would characterize the pipeline right now for acquisitions as being fairly active. As always, acquisitions are lumpy and hard to predict. What has historically slowed us down in converting more acquisitions has been the price valuation gap. I hope over the next couple of years we’ll continue to see that sellers’ expectations will come closer to reality, allowing properties to become more actionable. We will continue to evaluate share repurchase and acquisitions, making the best decision every quarter on behalf of our shareholders. Regarding share repurchase, just as opposed to pre-announcing, we’ll continue to be active, and as I’ve said before on these calls, we’ll communicate after the fact. We think that’s the best value creation for our shareholders. We won’t be buying into our own wind, and you’ll see us be active. Like I mentioned in my opening comments, our goal is to be a great generator of cash, and we will continue to do even better at that, but we want to be great deployers of cash and put it to work. Now, the $2 billion that you mentioned, Nathan, that’s sitting there, I would remind you that 99% of that is permanently invested overseas. There are certain constraints or factors that we have to consider when thinking about deploying that cash and we want to do so in the most tax-efficient manner for the benefit of our shareholders. We will look to put it to work, but there are factors to consider regarding that cash sitting overseas.

Okay, thanks very much. I'll pass it on.

Just a question. We are seeing improvements in energy prices, and I was wondering if you could give us some more color if you guys are seeing any impact on backlog or discussions with your customers?

Andrew, this is Lee Banks here. I would characterize the oil and gas situation pretty much as we did last call. Year-over-year, it's still down, but there is certainly an increase in rig counts taking place. However, it feels almost like we are at the bottom with a lot of choppiness in the market. So, there is no real catalyst for a significant change at this point in time.

And just a follow-up on M&A. I have literally had discussions where people are using negative interest rates for a cost of funding for deals. What is the equation between the prices and the cost of capital like in this environment? Are people becoming more reasonable given the macro situation, and how does it balance against the fact that you can borrow at almost nothing?

Andrew, it's Tom. The valuation disconnect I was referring to is that sellers continue to use a pre-2008 mentality as far as forecasting sales based on previous experiences. We buy properties that we know and understand; we buy things within our space. We have divisions that are in the same space. So we see what the market and our growth rates are, and typically there has been a disconnect in that. I see that disconnect getting closer, which allows things to be more actionable. Your point about financing is valid; we’re disciplined and have a certain discount rate we look at. We have return criteria that we consider, and all of this is to the benefit of creating value for our shareholders. We will continue to conduct robust reviews.

Thank you very much.

Nice quarter. Two questions. One, Tom or Jon, I'm just trying to understand better the margin guidance in International given the performance you put up in the first quarter, especially considering that you actually had a sales decline and your sales for the year are assuming positive growth. So I would assume you would get more leverage there. Can you provide a little color on that? And then my second question is just on the order front. I guess I was pleasantly surprised that North American declines are lessening, and we saw another positive order number out of international on a tougher comp. Can you give a sense of your comfort level that the OE channel is clear or when North American orders should start to inflect positively? Is that in the second half of the year? Also, whether you expect the strength in international to continue or when that starts to improve even more?

Yes, Jamie. A quick answer from me, this is Jon. The margin guidance for international was raised by 10 basis points, and we see great progress as a result of our restructuring actions and our simplification initiatives both company-wide and internationally. We found it prudent to move that up 10 basis points, and we’re really pleased with how we are performing there.

But, Jon, your margins in the remaining nine months of the year implied margins are lower than the first quarter, but we’ll get sales growth?

What we are doing in terms of the mix as the year goes on is to make sure that we get the best guidance out there. Please keep in mind that there are some seasonal impacts we are going to see in Q2, and that's indicated in our guidance, and that will have an impact on the international margins in Q2 and as typical also in Q3.

I'm sorry, what is the mix issue? Is it just more OE or can you give color on that?

The mix more reflects the inroads we are making and some of our businesses in Asia as well as in Europe, capturing more business, and we are seeing good increases in our sales there.

Yes Jamie, it's Lee. I want to answer your question and give some context around the markets globally. It's important to remember how we characterized the micro environment last quarter when we provided guidance for FY17. We expected a year where most of our market declines would decelerate and eventually reach flat. We forecasted growth to be soft in Q1, essentially flat in Q2, and then some small organic growth in year-over-year basis in the second half of the year. We categorized the markets into three buckets: positive, neutral, and negative. Positive growth includes aerospace, refrigeration, air conditioning, semiconductors, and telecom, and we continue to see strong activity in all those areas. Neutral includes automotive, power generation, and rail, and those markets are also reaching inline expectations. The negative markets still include natural resources and construction sectors that are struggling. Our organic growth for the quarter moved largely in the direction we had expected based on last call. Regarding North America distribution, we saw low single-digit declines, aligned with expectations where many are affected by natural resource markets.

Okay, sorry. Then just a question on order inflections for North American and International?

When I look at North America, we are seeing slight improvement, but the market is reacting slowly due to the historical recent declines. The international orders are performing well with positive movement across regions; Asia, Europe, and Latin America are seeing growth.

Thank you. That was very helpful. I will get back in queue.

Thanks, Jamie.

Can we just take a step back for a moment? I missed what you said about Turkey. Did you say Turkey was improving or Turkey was a bit of a headwind? You were talking about political activity.

Turkey was a little disrupted during the political unrest, but it appears to us to be getting back in line, and it was really some distribution business that went soft on us for a period.

Okay, that is helpful. And then Lat-Am orders accelerating. Can you talk about where exactly you are seeing the demand? Is it in distribution? Is it trucks? Just a little color by market or region?

These are all very low levels, so I don’t want to mischaracterize what’s happening. But trucks, construction equipment, and farm and ag have been positive.

Thank you. And then just a follow-up on your guidance. The dollar has strengthened against the euro by 4% since the end of the quarter. I know you said you expect your outlook based on September 30 exchange rates. If you were to use the exchange rates as of today, would you change your revenue guidance?

Ann, this is Jon. I think, yes. Given that track and we have a pattern of using September 30. We will see how that plays out for the balance of the year, but with the strengthening dollar today, I think it would have a slight impact on guidance.

Okay, I appreciate it. I will get back in line. Thank you.

First, guess my first question is there has been a lot of concern especially as we were exiting September that things in industrial have started to get a little bit worse. So I'm just curious whether you can provide any color on how things trended in the quarter and specifically that back half of September which has been a hot topic of conversation.

Joe, it's Tom. Through the quarter, we saw North American orders getting less negative, which is a good thing, and we’re seeing it progress sequentially that way into the quarter. internationally and aerospace, we are relatively consistent. In October, we haven’t seen anything unusual, and October has been consistent with our guidance.

Okay. Helpful, Tom. And then maybe just given that the earnings number came in a little bit better than expected, Tom, you kind of kept the guidance range wide for the year. I think historically you guys have kind of narrowed it in the first quarter. Just curious your thoughts around that, especially given the fact that order trends have gotten a little better?

Yes, two things. One, I’ll talk about the width of guidance; people may not have picked up on that. We started this year in August a little different than what we traditionally did. If you go back to that August guidance, typically it had a much wider range. So we started off the year with a narrower-than-traditional range in August and just kept it the same for the first quarter. The good news for what happened in the quarter is we met the guidance at the operating income level. The good thing about what happened is that we had slightly less sales but better operating margins, delivering the operating income to our guidance, which is a testament to the team doing a fantastic job there. We appreciate seeing better order trends, but I would like to see more data before we get too ahead of ourselves.

Got it. That makes sense. Maybe one last follow-up specifically on the below-the-line items in the guide. I know you guys made a voluntary pension contribution. I assume that was going to be a bit of a tailwind to your earnings for this year, but it looks like your corporate number has gone up. What is the natural offset there?

Yes, first of all, it’s not a big tailwind, but it is a slight few-cent tailwind with that additional contribution we made. Below the line, though, as Tom has talked about in many of our different venues over the last several quarters, our investments in R&D, our investments in e-commerce, and our investments in IoT are driving additional expenses that help offset that $0.05 impact from the additional pension contributions.

It's helpful, Jon. Thanks, guys.

On the quarter, could you provide a bit more color on the benefit to operating profit from restructuring and simplification?

Andy, this is Tom. Perhaps I will start strategically, and I will let Jon add the details on the quarter. Our simplification strategy has several elements, focusing initially on the division consolidations. This has been a natural starting action, but the more significant impact will come from managing revenue complexity, processes related to organization design, and bureaucratic inefficiencies. We’ve seen significant margin improvement as a result because simplification is targeted mainly at strategic SG&A, which is why we’ve performed efficiently in the last several quarters. I think we have a lot more runway here, as we’re just scratching the surface.

In terms of specifics in the quarter, we booked $0.06 in restructuring. We are maintaining our guidance for this year, and save 20% of the restructuring benefits will show in the first half. Restructuring booked in Q1 was slightly lower than projected, and we’re pleased with our progress.

Okay, thanks, Jon and Tom. If I step back a bit and look at the 2020 goals, you have mentioned confidence in achieving those. If I isolate the 17% operating margin goal, can you comment on whether you can get there if market stabilization happens but the markets kind of stay flat after? Or do you need some end market growth in addition to the 150 basis points you are targeting?

It's Tom again. What we project, including the 150 bps greater than the market, results in a 1.5% CAGR. Remember this CAGR starts in 2015 and went down to 2016. If we see stable growth through 2020 as we expect, then yes, we can achieve our 17% operating margin. Obviously, if it's lower, that will present some challenges. But we are cautiously optimistic that we can pull it off.

We’ve kind of touched on this, but with orders in North American industrial getting slightly better on a comp basis while revenue is down a little bit - about 40 bps - did the order patterns, despite improving, come in a bit lighter than you might have thought?

Joe, this is Tom. The sales gap we experienced—down by around $40 million—was somewhat balanced across our three segments: aerospace, North America, and international. For aerospace, it was due to slight softness impacting business jets, helicopters; for North America, it came from heavy-duty trucks and automotive. Internationally, there was minor underperformance primarily in Europe. Overall, our orders were largely on trend as expected, which is why we maintained our guidance.

Fair enough. If I could switch quickly to Aerospace for a bit; you mentioned margins suffered a bit from development costs. Can you elaborate on that? And after having two quarters in a row with 14% order growth, how much would you attribute that to comps getting easier or are you seeing real strength?

Regarding development costs, it's generally challenging to project quarter by quarter. It's more a timing issue than systemic challenges. On the order growth, let me clarify: we report these figures based on a rolling 12-month average, and the long-term growth rate we expect is around 4%. I would not anticipate continued 14% quarterly increases, as the lumpiness of orders varies, but we have solid long-term prospects.

Just a couple of quick follow-ups. I think, Lee, when you went around the horn on all the end markets, I didn't hear you mention anything regarding distributor inventory levels and whether stocking might be waning. Anything to comment there?

Steve, I don’t think it’s a big issue. There may be some pockets that I’m unaware of. Overall, though, it’s not something concerning when I speak with our channel partners.

Okay, great. Maybe for Jon, it feels like we’re slightly tweaking down the guidance, I guess, for fiscal second-quarter. Can you clarify if there are any below-the-line items that might bounce back or how we should consider that?

Yes, you’re right, slight downward adjustments are due to onetime events in Q1, not reflecting future issues. The normal cost structure remains favorable, and we've seen good volume following our line of orders, so it's just slight adjustments based on our Q1 performance.

Great. That is all I have. Thank you so much.

Just back on simplification and division consolidation. You’ve made a great effort early on, but can you speak to the major opportunities ahead? Additionally, Lee, you touched on international distribution; could you expand on that?

For simplification, our biggest pull is managing revenue complexity. We’ve got a large number of part numbers tied to a small revenue percentage, inflating costs contradict the efficiency we seek. Associated organization design and process improvements will contribute to a greater customer experience. I believe we’re just starting this process but expect significant results. Lee will discuss distribution.

We consider our distribution network one of our greatest off-balance sheet assets. We aim to establish a similar network internationally to what we have achieved in North America. Over the last 12 to 15 months, we have focused on emerging markets in Europe and the Asia Pacific, and we’re encouraged by our progress.

Okay, thanks, guys.

Just a couple of questions of clarification. I just wanted to ensure I understood what Jon said about restructuring. You mentioned 20%. Were you saying 20% of the restructuring benefits will apply in the first half? Please clarify that.

You got that right; 20% of the savings we’re getting from restructuring this year will be in the first half.

On Aerospace, with developments and order flows, what level of R&D or E&D should we expect to see as we approach the 2020 horizon?

Currently, we’re around 8% and have moved from 11% in previous years. Our aim is within the 7% to 8% bracket, and while we may fluctuate, today we see 8% aligning with customer expectations.

Just a question on the CapEx. The first quarter you had $32.5 million which is about 1.2% of sales. That is about half of what you normally do which in turn is half as a percent of sales compared to what it was 10 years ago. What do you expect CapEx to be for the year? What percentage of sales?

It will be in the range of 1.6% to 2.0% for the year.

Okay, so that is going to be a pretty low figure compared with what you were 10 years ago.

We’re nowhere near the required capital from ten years ago. Yes, these numbers include significant reinvestments in the company, but it's clear that our lean efforts have transformed our capital expenditures fundamentally.

Is it just a matter of raising your margins, increasing profits, and allocating them to CapEx or acquisitions?

Yes, we feel strongly about our positioning from a CapEx standpoint, and we remain disciplined, assessing IRR for acquisitions and capital allocation.

I have one suggestion; on the slide listing your cash flow, a simplified cash flow statement would be very helpful. You are not presenting the individual components to easily see changes in inventory and working capital.

That’s a good suggestion; we will take a hard look at that for better clarity in future slides. I think that concludes our Q&A earnings call. Thank you all for joining us today; Robin and Ryan will be available throughout the day to take your calls should you have any further questions. Thank you and have a great day.