Parker-Hannifin Corp (PH) — Q2 2018 Earnings Call Transcript

Thank you, Kevin. Good morning, and welcome to Parker-Hannifin's second quarter fiscal year 2018 earnings release teleconference. Joining me today are Chairman and Chief Executive Officer, Tom Williams; and President and Chief Operating Officer, Lee Banks. Today's presentation slides, together with the audio web cast replay, will be accessible on the company's investor information web site at phstock.com for one year following today's call. On slide number 2, you'll find the company's Safe Harbor disclosure statement, addressing forward-looking statements, as well as non-GAAP financial measures. Reconciliations for any reference to non-GAAP financial measures are included in this morning's press release and are also posted on Parker's web site at phstock.com. Today's agenda appears on slide number 3. To begin, our Chairman and Chief Executive Officer, Tom Williams, will provide highlights for the second quarter. Following Tom's comments, I'll provide a review of the company's second quarter performance, together with the guidance for the full year fiscal 2018. Tom will then provide a few summary comments and we'll open the call for a question-and-answer session. Please refer now to slide number 4, as Tom will get us started with the highlights.

So thank you Cathy and good morning everybody. Thank you for joining the call and of course your interest in Parker. So let me just make a few general comments and I will get into the quarter specifically. A top focus of the company continues to be safety and the engagement of our people. These are obviously interconnected, as we improve safety for all of our team members and we have higher levels of engagement across the company, we will continue to drive higher operating improvements. When you look at orders for the quarter, there is very strong momentum across a wide range of markets and geographies; I am very excited about that. Organic growth was very strong, much faster than industrial production growth, and this is our fourth quarter in a row that we exceeded industrial production growth. The Win Strategy initiatives, when you look at the improvements in growth and operating margins continue to evolve, and we really feel we have got a bright future ahead of us. If you look at the progress over the last few years, it has been remarkable. But I would just characterize that we are still in the early days of implementing the Win Strategy. My thanks to everybody around the world, all the Parker team members for all your hard work and your efforts and looking forward to a bright future. So let's get into the quarter, it was solid and really a great first half of the fiscal year, and I will go through a couple of key stats. Safety performance, 22% reduction in recordable injuries, which is very nice. Sales was an all-time record for the second quarter, up 26%. Organic growth was approximately a 10% increase, significantly outpacing industrial production growth, and order entry rates increased 13%, making it the highest order entry rates that we have seen since Q4 of FY 2011. A couple of comments on margins, because it is difficult to look at margins year-over-year, as the prior period did not include CLARCOR, but this period does. When you look at adjusted segment operating margins, they continue to improve; we came in at 14.9%. But if you were to add back the incremental depreciation and amortization from the CLARCOR acquisition, you would add 90 basis points back to that number, which brings it to 15.8%, representing a 110 basis point improvement versus the prior year. Another way to look at it, is that the EBITDA margins for the quarter came in at 16.3%, again, a 110 basis point improvement, if you adjust for the divestiture gain that we had in last year's second quarter. When looking at adjusted EPS, it increased 26%, excluding the divestiture gain from last year and accounting for a $225 million net one-time negative adjustment due to new tax legislation. Cathy will provide more details in her comments. Our goal is to effectively generate and deploy cash. This theme is central to our company, and we are on track to deliver substantial cash flow over the next several years. Although the new U.S. tax reform resulted in a negative one-time adjustment for the quarter, it presents long-term benefits by creating a more competitive environment and leveling the playing field with foreign competitors. This offers us an opportunity for market share gains and is likely to influence our customers' investment decisions due to the treatment of capital expenditures in the new tax law. It is evident that the law will promote capital expenditures, which will, in turn, drive more content related to our operations. We are also building greater flexibility in managing cash globally, providing a significant advantage for shareholders. Our deployment priorities remain unchanged, yet we enjoy increased flexibility. The top priority is to continue our tradition of raising annual dividends. We aim to maintain our long-standing record, which highlights our ability to consistently generate cash over time and underscores our status as a strong long-term investment for shareholders. Our target for dividends is 30% of net income over a rolling five-year period, meaning as our net income rises, so will our dividends. The second priority is capital expenditures for organic growth, which is the most effective way to utilize capital on behalf of shareholders. The strength of our business model and cash flow generation allows us to have approximately half of our cash available for deployment. In the near term, we are going to reduce leverage with the CLARCOR deal. We are also going to continue our 10b51 share repurchases. As the debt reduces, we are going to re-evaluate acquisitions and discretionary share repurchases, with the goal always being to deploy capital in the best long-term fashion on behalf of our shareholders. I remind everyone that we utilized overseas cash to help fund CLARCOR, so we have already put most of that overseas cash to work. Regarding our outlook, specifically for the full year; with safety, it’s hard for me to predict a full year there, but injuries are down 22%, and we obviously want to continue that trend. Overall sales are expected to be up 17% versus prior year and adjusted EPS is projected to be up 21% versus last year, with adjusted EBITDA margins forecasted to be 17.6% for the full year versus 16.3% last year, representing a 130 basis points improvement while excluding the divestiture gain from last year. We are increasing EPS, adjusted EPS by $0.45 at the midpoint, so our new range is $9.65 to $10.05, reflecting the reduction in the U.S. federal tax rate, and our year-to-date results regarding realignment in CLARCOR costs achieved, which will be at the same levels that we previously anticipated.

Okay, thanks Tom. I will now refer you to slide number 5, and begin by addressing earnings per share for the quarter. Adjusted earnings per share for the second quarter were $2.15 compared to $1.91 for the same quarter a year ago. When comparing to the second quarter fiscal 2017 results, please recall that last year included a $45 million or $0.21 per share gain on the sale of our product line, which was not adjusted out. Excluding this product line gain, adjusted earnings per share increased 26% from the same quarter last year. The respective adjustments for both years are as follows; fiscal year 2018 second quarter operating income adjustments include business realignment expenses of $0.07 and CLARCOR cost to achieve of $0.07. This compares to $0.04 for business realignment expenses in the second quarter in fiscal year 2017. Other expenses in fiscal year 2018 have been adjusted to exclude a net gain of $0.05, which includes a gain from the sale of assets, offset by the write-down of an investment. Prior year other expense was adjusted for $0.09 of acquisition related expenses. Last but not least, fiscal year second quarter 2018 has been adjusted for the net one-time impact from U.S. tax reform of $225 million or $1.65. I will discuss this adjustment in more detail on slide 13. If you move now to slide number 6, you will find a significant component of the walk from adjusted earnings per share of $1.91 for the second quarter of fiscal 2017 to $2.15 for the second quarter of this year. The most significant increase came from higher adjusted segment operating income of $0.62, attributable to earnings on meaningful organic growth, income from acquisitions and increased margins due to our new Win Strategy initiative. I'd like to point out that this $0.62 improvement is net of incremental depreciation and amortization expense of $0.16 taken on with the CLARCOR acquisition. The lower effective income tax rate equated to a year-over-year increase in earnings per share of $0.07. Adjusted earnings per share was reduced by $0.31 on the other expense line, primarily due to the non-recurring $0.21 per share gain from the sale of a product line included in the prior year. Higher interest expense was an $0.11 drag, together with slightly higher corporate G&A and share count, equating to a $0.03 per share reduction. Moving to slide 7, you will find Parker's total sales and segment operating margin for the second quarter. Total company organic sales in the second quarter increased year-over-year by 9.5%. There was a 13.3% contribution to sales in the quarter from acquisitions, while currency positively impacted the quarter by 3.4%. Total segment operating margin on an adjusted basis improved to 14.9% versus 14.7% for the same quarter last year. I'd like to remind you that the fiscal 2018 operating margins include incremental depreciation and amortization from the CLARCOR acquisition. Without this incremental expense, margins would have improved 110 basis points. This margin improvement reflects the benefits of higher volume, combined with the positive impacts from our Win Strategy initiatives. Moving to slide number 8, I will discuss the business segments, starting with Diversified Industrial North America. For the second quarter, North American organic sales increased by 12.7% compared to last year. Acquisitions contributed 26.3% to sales, while currency also positively impacted the quarter. Operating margin for the second quarter on an adjusted basis was 15.1% of sales versus 16.6% in the prior year. The current year includes 160 basis points of CLARCOR related incremental depreciation and amortization expense. Without this, margins improved by 110 basis points. I will continue with the Diversified Industrial International segment on slide number 9. Organic sales for the second quarter in the Industrial International segment increased by 10.7%. Acquisitions positively impacted sales by 6%, while currency positively impacted the quarter by 8.1%. Operating margin for the second quarter on an adjusted basis was 14.2% of sales versus 13.1% in the prior year. I will now move to slide number 10, to review the Aerospace Systems segment. Organic revenues increased 0.8% for the second quarter. Strengths in both commercial and military aftermarket more than offset weakness in OEM activity during the quarter. Operating margin for the second quarter, adjusted for realignment costs, was 16% of sales versus 13.5% in the prior year, reflecting the impact of a favorable aftermarket sales mix and lower development costs during the quarter. Moving to slide 11, we show the details of order rates 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 continue to be strong, improving to a positive 13% for the quarter end. This year-over-year improvement is made up of 15% from Diversified Industrial North American orders, 13% from Diversified Industrial International Orders, and 8% from Aerospace Systems Orders. On slide 12, we report cash flow from operating activities. Year-to-date cash flow from operating activities was $460 million or 6.8% of sales, compared to 7.5% of sales for the same period last year or 11.5% last year adjusted for a $220 million discretionary pension contribution. The significant capital allocations year-to-date have been $176 million for the payment of shareholder dividends, $145 million or 2.2% of sales for capital expenditures, and $100 million for the company's 10b51 repurchases of common shares. On slide 13, I will now take a moment to discuss the impact of U.S. tax reform. In the second quarter, we incurred a net $225 million charge, that includes a $287 million one-time charge for the deemed repatriation of non-U.S. earnings, offset by a favorable $62 million adjustment to our net deferred tax liabilities due to the new 21% federal rate. I need to mention that these one-time adjustments are our best estimates at this time; however, the amounts may change as we continue to analyze the impact of tax reforms. Due to our June 30 fiscal year, our statutory U.S. tax rate for fiscal year 2018 is blended at a 35% rate for the first half of the year, and a 21% rate for the second half of the year, which results in a 28% full-year U.S. statutory rate. This reduced rate will have a favorable impact on cash for fiscal year 2018. As for the long-term implications, the U.S. tax reform will result not only in increased net income, but we can benefit from improved mobility of our non-U.S. cash. The full-year earnings guidance for fiscal year 2018 is outlined on slide number 14. Guidance is being provided on both an as reported and adjusted basis. Total sales increases are expected to be in the range of 15.3% to 18.9% as compared to the prior year. Anticipated full-year organic growth at the midpoint is 6.5%, which is 100 basis points higher than our previous guidance. Acquisitions in the guidance are expected to positively impact sales by 8.1% and currency is expected to have a positive 2.5% impact on sales. We have calculated the impact of currency to spot rates as of the quarter ended December 31, 2017, and we have held those rates steady as we estimate the resulting year-over-year impact for the remaining quarters of fiscal year 2018. For total Parker, as reported segment operating margins are forecasted to be between 15.3% and 15.7%, while adjusted segment operating margins are forecasted to be between 16.1% and 16.5%. Full-year tax rate is now projected to be 25%, down from our previous guidance of 28%. For the full year, the guidance range on an as-reported earnings per share basis is now $7.38 to $7.78 or $7.58 at the midpoint. On an adjusted earnings per share basis, the guidance range is now $9.65 to $10.05 or $9.85 at the midpoint. In addition to the full year net loss of $5 million resulting from the combined gain on sale and writedown of assets and the net provisional tax charge of $225 million, this guidance on an adjusted basis, excludes business realignment expenses of approximately $58 million for the full year fiscal 2018. Savings from business realignment initiatives are projected to be $25 million. Additionally, guidance on an adjusted basis excludes $52 million of CLARCOR cost to achieve expenses. CLARCOR synergy savings are estimated to be $58 million in fiscal year 2018. We continue to remain on pace to realize the forecasted $140 million run rate synergy savings for CLARCOR by fiscal year 2020. We 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 2018 guidance at the midpoint are; sales are divided 48% first half, 52% second half. Adjusted segment operating income is divided 45% first half, 55% second half. Adjusted earnings per share, first half second half is divided 45%, 55%. Third quarter fiscal 2018 adjusted earnings per share is projected to be $2.59 at the midpoint, excluding $0.08 of projected business realignment expenses and $0.09 of projected CLARCOR costs to achieve. On slide 15, you will find a reconciliation of the major components of fiscal year 2018 adjusted earnings per share guidance of $9.85 at the midpoint compared to the prior guidance of $9.40 per share. Increases include $0.14 from higher segment operating income, $0.41 from a lower effective tax rate, and $0.01 from lower projected corporate G&A. Offsetting these increases is a $0.08 per share decrease from higher forecasted interest and other expense, and $0.03 per share from increased fully diluted share count. Please remember, that the forecast includes any acquisitions or divestitures that might close during the remainder of fiscal 2018. This concludes my prepared comments. Tom, I will turn the call back to you for your summary comments.

Thank you, Cathy. So we are pleased with the strong first half of the year that we have had. A combination of our sales growth, the lower cost structure that we have built, integration of CLARCOR, and execution of the Win Strategy; that combination is projecting for us to have the best fiscal year that we have ever had in the history of the company, with an all-time sales record. My thanks to everybody around the world, Parker team, for all your hard work and efforts in creating that. At this point, let me hand it back to Kevin. We will start the Q&A part of the call.

Thanks. Good morning everyone.

Good morning Joe.

Can you briefly discuss the North American margins? This seems to be a significant focus today. You've mentioned the effects of the CLARCOR acquisition and how it's affecting your margins. Did the margin figures change from quarter to quarter? The margins were lower this quarter compared to the previous one. Additionally, can we explore the various factors influencing the margins this quarter?

Okay, so Joe, this is Tom. Maybe to help everybody, I am going to run through the margins and give you back the incremental depreciation and amortization when we have no CLARCOR deal. Cathy did that and I am going to summarize it again just so you have it. So, North America, if you add back the 160 basis points of incremental depreciation and amortization, North America's operating margin for the quarter would have been 16.7%. Internationally, if you add back 40 basis points, international's margins would have been 14.6%. Aerospace, obviously not impacted, would be at 16.0%. Total Parker, if you add back 90 basis points, it would come to 15.8%. So when you look at it all in, North America still was higher by 10 basis points versus prior year. There are some challenges that we have faced in the quarter and when you just look at the mix of order entry and sales. While we are excited about our sales growth, the mobile part of that was drawing at a faster clip than industrial and distribution. We have mobile growth at approximately 20% for the quarter, with industrial growth in the high single digits, and distribution in the low teens. That mix is putting a little bit of margin headwind for us, and we had a number of plant closures, which can lead to inefficiencies. We are right now in the heat of the restructuring for CLARCOR, particularly around the manufacturing footprint consolidations. To give you some color, last year we closed 23 plants for the total company. This year, we have closed 39. That level of plant closures incurs impact on efficiency and serves to tighten our margins.

That's helpful Tom. I guess the follow-up question is whether this quarter represents the lowest point we should expect regarding inefficiencies from the plant closures, or could this be a factor that negatively impacts North American margins for the next few quarters?

Well, it's in our guide; North American margins for the full year are expected at 17.2% for the full year, which is a pretty nice performance. However, we are right now in the middle of this; we experienced it this quarter, and we probably will see for the next two quarters. Remember, this is a three-year synergy plan we are laying out. The bulk of it, the heavy lifting from a footprint standpoint is in the last quarter we just experienced, really in the next six months. Even with that, we have got margins at very good levels with EBITDA, which is a nice way to look at it because it takes out depreciation and amortization, growing to 17.6% versus 16.3% last year.

That's helpful. If I could maybe sneak in one more about the end of the calendar year. We have been hearing from some of our companies that because organic growth surprised on the upside and the growth in North America was extremely strong, there were higher rebates to distributors that came through in the fourth quarter. Did you experience any of that, considering 50% of your business sells through distribution?

This is Lee. You know, we did have great sales during the quarter and order entry continues to accelerate. But there is nothing meaningful regarding rebates or anything like that that has been factored in to what you have seen.

Okay, got it. Thanks guys. I will get back in queue.

Thanks Joe.

Hi. Good morning.

Good morning Ann.

My question has been answered regarding the North American margins, so that information was helpful. I'd like to shift focus to Aerospace. Can you discuss your current mix of business and where you see it heading? If I remember correctly, you have a stronger position than the 747 and the A380, which are programs that may be coming to an end, and you also have a solid partnership with Embraer. How would your relationship with Embraer be affected if Boeing were to acquire the company? Could you provide some background on your Aerospace business?

Ann, I will start out. In the quarter, we had an unusually strong mix of aftermarket, both commercial and military. And that came with higher margins, since our aftermarket typically has higher margins, but it was also a very favorable mix of aftermarket. It was a little unusual in the quarter; however, in the third quarter, we see our strongest aftermarket activity. So the third quarter should be a similar mix, but it's not necessarily a full-year mix we would normally expect. We have platforms that are slowing down in wide-body, and we see a lot of slowness in the market. But keep in mind that we are very diverse in our portfolio, and there are also new programs coming on. So while some of them are shutting down or slowing down, we are also seeing growth in platforms like the A350 and the Global 5000. Our portfolio mix helps balance the impact that you are describing, and you won't see a significant impact.

Okay. So you are suggesting that fiscal Q3 should have strong margins and then taper off? Is that what I should read in the near term?

The Q3 tends to be our strongest quarter for aftermarket. It's when the OEs, the large airlines are having the planes typically brought in for repairs. So the third quarter should be good, yes.

Okay. I will leave it there and get back in queue. Thank you.

Alright. Thanks Ann.

Hey guys, how is it going?

Hi Joel.

I would like to combine my questions. I'm curious if Tom or someone else could elaborate on the fact that the order strength seems to be significantly higher than what was suggested earlier this year for the second half. It appears your implied order growth was nearly flat, so I'm wondering what has changed. Is there anything that might undermine your confidence in the sustainability of this growth? Additionally, could Lee provide some insights into the different regions and highlight the various aspects of the businesses? Thank you.

Okay, Joel. This is Tom, and I will hand it to Lee shortly. Regarding order entry, we have revised our sales forecast, increasing our organic growth guidance from 5.5% to 6.5%. The assumptions for acquisitions and currency remain unchanged. The updated guidance reflects an increase of 100 basis points. Specifically for the second half, we have raised our forecast from 3.7% to 5.0%. We are optimistic about the macro markets and do not see any weakening from an economic standpoint; Lee will provide more details on that. Our sales estimates are based on the comparisons from the previous year, where we experienced plus 6% organic growth in the second half of FY 2017; thus, our plus 5% forecast builds upon that. We are confident about the macro conditions.

Joel, it's Lee. I'm not going to comment on Aerospace, I think Cathy did a great job on that. I would just say industrially, as you look through all our end markets, it’s really hard to find any significant markets that did not continue to show positive year-over-year order entry growth during the quarter. Some of these markets fell a long way, especially when it comes to natural resources, but they continued to show growth during the quarter. We saw strong growth in construction equipment, mining, oil and gas, which is mostly land-based. Other markets like semiconductor, microelectronics, heavy-duty truck, and distribution were strong. Land-based oil and gas showed an increase in active rigs and we are also starting to see quote activity with some customers that we haven't seen much in the past. They are doing more than just refurbishing what they have in the field. We also saw a great continued rebound from our distributor partners around the world, almost every region showed double-digit order entry which is really nice, and they continue to be very optimistic. The only notable market that we see contraction in, which has gotten a lot of press, is large-frame power jet. That has had a negative impact. In North America, we've continued to be very encouraged by all the increasing end market activity. It seems that it's somewhat firing on all cylinders. Throughout EMEA, we are seeing continued strong order entry growth. This would be the second year we are forecasting organic growth and during a long trough where we didn't see that. In Asia, Japan, Korea, China continue to be strong, and Southeast Asia is showing good results as well. Lastly in Latin America, there seems to be some positive momentum in Brazil, despite all the politics. We are hopeful there continues to be a turnaround.

That's really super. Thank you.

Thank you.

Thanks Joel.

Thank you. Good morning everyone.

Hi John.

Cathy, hi. The tax rate was a little lower in the second quarter. I don't think you talked about it. What was that about?

Sure. Let me reiterate for the year. We expect it to be 25%. We are at a 28% blended rate for U.S. federal. In December, we adjusted everything to that new blended rate. As part of that, you do a catch-up of what you had booked provisionally in the first quarter, and you catch up the year for the six months to your assumed effective rate for the full year. So you get a little bit of a double benefit in December from the lower tax rate for the year.

So I am trying to understand; tax reform is a calendarized impact. Are you saying that this is actually a result of tax reform?

Yeah, correct. It was effective January 1, but for us, it became half effective. What they require us to do is take the number of days that we would be at a 35% rate and the number of days we'd be at a 21% rate, and that comes to a 28% effective rate for our full fiscal year.

Okay, that makes more sense. I understand now. Thank you. What about the mix of orders? Tom, you mentioned stronger OE and the ramp-down in terms of the plants, but the stronger OE seems to be affecting pricing margins slightly negatively. Is this reflected in the mix of orders that you are observing, so we should expect that type of OE mix to continue in the upcoming quarters?

John, it's Tom. Yes, it would, and that's what factored into our guidance, part of why we left margins the same as our prior guide, because of that. But over time, that’s going to start to stabilize. And those things; the high spike in mobile activities is going to start to stabilize at a lower number, and I think this imbalance will shift a little bit more to mobile, becoming more in check as we go throughout the next several quarters.

Right. So mobile is clearly accelerating and I think you could make that claim globally. What's happening with respect to distribution then, at the high single digit? I think you called out that run rate is that actually accelerating at a lesser cadence, or is it sort of steady?

I don't think that's the right way to describe it. I'll let Lee add to that. Distributions are currently in the low teens, and I would say they are stable. They are experiencing high levels of stable growth, but I expect that will decrease to around the mid-single digits in the second half, mainly due to comparisons with last year's figures.

CLARCOR also, I think we took your guide from what $0.20 to $0.33. Was that all tax? Or is the business actually getting better?

I am sorry; I didn't quite understand what you are asking about, John?

The EPS accretion from CLARCOR. I calculated, it looks like it is about $0.33 for fiscal 2018, and I thought you had said it was going to be about $0.20. Maybe that's not true. I am just wondering, are you expecting CLARCOR accretion benefits to improve from what you had last said, I think last year, right?

Yeah, John. We are still at about a $0.20 accretion for CLARCOR for fiscal 2018.

Fiscal 2018? Okay.

Yeah.

I wanted to ask Tom a strategic question. Is there an opportunity to potentially migrate some of your smaller customers to the distribution side in order to reduce operating costs and enhance Parker-Hannifin productivity over time?

Clearly, John, you hit the nail on the head. What you are referring to is really part of our simplification program, particularly as it relates to revenue complexity. We look at all of our revenue and our products. Clearly, when we look at that tail, that's one of the areas we are examining, and we moved some of that product to distribution, so distributors can do a better job of servicing the customers in that regard.

I am curious about where you currently stand in implementing that. Is it still in the early stages, or have you actually started? You've done an excellent job with margin expansion, so we are all considering the next steps. We can compare Parker to ITW or other companies with higher margins. The thought process revolves around the different levers you could potentially use to enhance your overall profitability moving forward.

Yeah, we see more opportunity obviously, and that’s something we will go into more detail at Investor Relations Day. But when I think about simplification, lean, strategic supply chain, value pricing, all those things underneath the financial performance initiatives, I would characterize them as having lots of upside. The revenue complexity piece that we just discussed is really in the first inning, so there is lots of upside there.

Where do you currently stand in terms of implementing those changes? Is it still at a very early stage, or have you actually begun? You've done an excellent job with margin expansion, and we are all considering what the next steps might be. We can compare Parker to ITW or other companies with higher margins. The idea is to explore the various strategies you might utilize over time to enhance your overall profitability moving forward. Got it. Thanks so much. Appreciate it.

Thanks John.

Hi guys. Good morning still, I guess.

Good morning, Andrew.

Just a question on international margins, just in your outlook, you are actually modeling them now a little bit lower than before, and I was wondering if that's the impact of mobile mix and what else is going on there? Is the dynamic there similar to what you guys are seeing in North America?

Yeah Andrew, it's Tom. It would be the mobile mix, because most of our heavy plant closures are in North America. A little bit in Europe, but North America is where we are seeing the closures the most. For the international piece, we changed the guide by 10 bps, and it's mainly the mobile mix.

And just a question in terms of dealing with high volumes and maybe this is sort of a three-pronged question; just focused on distributors, do they need to change their behavior, do you have enough capacity, and finally, working capital impact? Just because volumes are going up a lot faster than you guys thought?

Andrew, it's Lee. I think if I understood your question, it's whether we have to do anything different to handle the volume increase.

That's exactly right. And working capital requirements, exactly.

No. I'd say from a working capital requirement standpoint, obviously when you have a huge influx in business, there can be some tax receivables for a period of time. But the biggest working capital requirements we've had throughout the quarter and really the first half of the year have been with all these plant closures. There has been a conscious build of inventory in some areas so we don’t impact our customers. With revenue, with our OEM customers, nothing changes; some customers are categorized with high runners, running through the shop.

Good problems to have. Thanks a lot.

Thank you.

Thanks Andrew.

Hi, good morning. I have two questions. First, in the recent quarter and looking ahead for the rest of the year, are there any updated assumptions regarding price costs or your ability to adjust pricing in the market? Can you share how that is progressing?

Jamie, it's Tom. I'll start with your last question, then I'll let Lee talk about price costs. Yes, once we get through the heavy lifting, we would expect things to normalize. The other part that's going to help us, once we anniversary CLARCOR, we can look at the total company apples-to-apples, and it’s going to be a lot easier, and our Q4 is the first time we get that apples-to-apples. We expect to see overall margin levels return higher.

Then Jamie, on price costs, I would tell you that there clearly is inflation on the horizon. You can see materials indexes, we've seen it in copper, and other materials. We have been through these cycles before. At this point, from a price-cost standpoint at a corporate level, we are good. But we are taking actions to stay ahead of this as we go forward.

Okay. That's helpful. Thanks. I will get back in queue.

Thank you.

Thanks Jamie.

Good morning everyone.

Good morning Nathan.

I want to address the North American margin issue once again. Tom, you mentioned that the number of facility closures increased from 20 to 39 this year. Can you provide some insight into how this disruption has impacted us, including the necessity to build inventory? Additionally, are you aiming to reduce this number back down to around 23 in 2019, and what is your anticipated reduction in facility closures for that year?

For 2019, we haven't fully worked that out. But clearly the bulk of the CLARCOR activity will be through. There might be some residual things we will do with plant closures. But we haven't clearly laid out what the rest of the business will look like at that point. But this spike in plant closures is significant. We have a policy in how we account for adjustments, so we only count the adjustments you can tie clearly to plant closures, severance, and those kinds of things. We know intuitively, closing a plant impacts both the sending and receiving plants. So it is real and typically any plant closure, even a well-laid-out closure feels that for three to six months. We are at that point now. The integration is the biggest acquisition we have done with the largest synergies we've ever planned, and we feel very good about it. But we are currently in the thick of the restructuring. I commend the teams for managing this well, and keeping our margin outlook intact with these challenges.

Okay. Then my follow-up is on one of your prepared comments, where you said you feel that the change in the tax bill would open up share gain opportunities for you and drive customer CapEx. Can you maybe talk a little bit more about where you see those share gain opportunities? I know it's early on the customer CapEx side, but perhaps what your expectations are on that front?

Yeah Nathan, it's Tom. The CapEx is just a general comment. By encouraging investment through tax laws with immediate expensing for CapEx for the next five years, that must be somewhat additive to the current macro environment. So I take a strong macro economy, add that encouragement there, and I think it bodes well for CapEx in general. How it plays through, and exactly what areas, that's yet to be determined. Regarding share gain, we have a number of foreign competitors who have had distinct advantages for some time. Now that we have a level playing field, I like our chances against them.

Okay. Fair enough. Thanks very much.

Thanks Nathan.

Thank you. Good morning.

Good morning Jeff.

A lot of talk obviously about integration and plant closures CLARCOR related. I am wondering if you step back and look at the CLARCOR footprint; you have also done a lot of restructuring here over the last several years, and now we are hitting a pretty big business inflection. How do you feel about the footprint right now, actually adequacy of the footprint, and what's the trajectory of your own CapEx looking like the next year or two?

Jeff, it's Tom. Our CapEx will continue to be about 2% of sales. We have been running at the 1.7% to 2% range, and I would see it at that level. I will expand more at IR Day, on strategic thoughts around this. As far as restructuring going forward, I want to calibrate you on what we have done so far; there is a lot more we can do. We are clearly making strides, and heading for the first time in the company’s history over $14 billion in guidance. I encourage you to look back at what the last all-time high was; it was $13.2 billion in FY 2012 with 59,000 team members. By crossing that guidance threshold with 2,500 fewer people, clearly shows the efficiencies we’ve built. I reiterate that we still see opportunities to continue improving structure—those four key elements I referenced: simplification, lean practices, supply chain efficiencies, and value pricing will enhance our margins moving forward.

And then just briefly on M&A; obviously you are deleveraging and divesting here still primarily. But do you see bolt-ons coming into your view, anywhere in the portfolio, and maybe particularly in filtration?

M&A is obviously something that we remain engaged with all the time; it is important for building relationships. We have the strategic candidates in the portfolio that we would like to add, and we are working on that process every day. As we begin to reduce debt, we will look into making additions to our portfolio. All things being equal, we would like to invest more into Filtration, Engineered Materials, Aerospace, and Instrumentation due to their strategic reasons, resilience, and overall margin potential.

Thank you very much.

Thanks Jeff.

Hey, good morning.

Good morning Jeff.

Can you discuss how you are approaching CLARCOR cost synergy savings in the second half compared to the first half?

Yeah. We are going to have $58 million of savings that we enjoyed this year in fiscal 2018. About 35% of that went in the first half and we expect 65% in the second half.

Okay, great. Tom, you mentioned the debt paydown. What's the updated timing for when you would start transitioning away from debt reduction?

There's no formal timeline; it depends on opportunities that present themselves. But we want to get closer to a two times EBITDA multiple. We started at 3.5 when we first did the deal and currently, we are at 2.9. We are making good progress; we want to continue to show that as we get into a better position from a debt standpoint, we'll begin to look again.

Jeff, I will add that we do have some term debt at $450 million due in the fourth quarter of 2018 and $100 million due in the first quarter of 2019. So you can count on that term debt being liquidated.

Okay. Thanks.

Okay, I think we have time for one more question please.

Hi, good morning. Thanks for letting me in.

Good morning Josh.

Just to maybe come full circle on all the North American margin questions; I know that there are usually some corporate true-ups that happen in the second quarter, as is seasonally always the case. Did those look any different than normalized? I know we have beaten it at this point, but I just...

Yeah Josh. Let me point out that the majority of the impact from those true-ups from incentive comp hits down below the line; when looking at segments it's down in corporate G&A. We did have adjustments, but nothing unusual compared to other years in this quarter. I don't think that those were a driver of what you’re looking at; and they are not a margin impact.

Got you. And then just on the tax rate, I guess all that implies in the second half, but still above the 25%, just given how you had a lower first half. How should we think about kind of the go-forward rate, more of an annualized or fiscal 2019, however you want to think about it rate? Is it still kind of just 26.5% or are you really at 25%, once we get through all the initial payments?

For fiscal 2018, we are at a statutory U.S. rate of 28%. When we combine this with our international rates and consider all the other elements that have emerged so far, we are estimating a rate of about 25% for the year. Beginning in fiscal 2019, we will have a true statutory rate of 21% for the U.S., which will reduce our overall rate. We expect our ongoing rate from 2019 onward to be closer to 23%.

Got you. That's helpful color. Appreciate that.

Okay, you're welcome. Alright thanks Josh. That concludes our Q&A and our earnings call. Thank you for joining us today. Robin and Ryan will be available throughout the day to take your calls should you have further questions. Thanks everybody. Have a good day.