Earnings Call: Q4 2015

Aug 4, 2015

Summary

FY 2015 sales fell 4% as currency offset flat organic growth, while adjusted margins improved to 14.9%. FY 2016 guidance anticipates slightly lower sales, higher margins and adjusted EPS of $6.65–$7.35, supported by cost actions.

Good day, ladies and gentlemen, and welcome to the Q4 2015 Parker-Hannifin earnings conference call. My name is Mark, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session. If any time you require operator assistance, please press star followed by zero, and an operator will be happy to assist you. I would now like to turn the conference over to Jon Marten, Executive Vice President and CFO. Please proceed, sir. 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 slide, 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 for 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. 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 am going to take a few minutes to share 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 are already being implemented. I would like to start with a few comments on our fourth quarter. We are 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 U.S. and a broad range of other actions to reduce costs globally, such as reductions in force, reduced work schedules, and tight control discretionary spending. Sales declined 11% in the fourth quarter as the effects of changes in currency rates negatively impacted us by 6%, and our organic sales declined 5%. Order rates were 9% lower in the fourth quarter compared with the same quarter last year. This follows a 4% decline in the third quarter. We are 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. Holding 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 due largely to changes in the geographic mix of pre-tax 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 regard 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 the 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 to 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 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 repurchased approximately $1.3 billion under our plan to purchase $2 billion-$3 billion worth of Parker shares over two years, which began October 2014. Our efforts to reenergize the pipeline of acquisition opportunities are proving effective as we are 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, $6.85, or $6.65 to $7.35 per share on an adjusted basis. This guidance includes an increase in adjusted segment operating margins from 14.9% to 15.4% for FY 2016. Guidance for fiscal 2016 includes business realignment expenses 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 cost, 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 profitable growth. We do anticipate a bottom forming in the 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 Winovation. 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 22nd, 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 are 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. For now, I'll hand things back to Jon Marten just to give you some more details on the quarter. Thanks, Tom. At this time, transitioning to slide number 6, I will address the earnings per share for the quarter. Adjusted earnings per share for Q4 was $1.43 versus $2.06 for the same quarter a year ago. This equates to a decrease of $0.63. This excludes restructuring and voluntary retirement expenses of $0.16, which compares to $0.08 for the same quarter last year. Please also note that in Q4, we made numerous tax adjustments that amounted to $0.30 per share due to the mix of pre-tax profits, noted in the quarter and a few discrete items that were incurred. Adjusted earnings per share for the full year 2015 were $7.25 versus $6.94 for the full year of 2014. Total realignment expenses were $0.28 for the full year 2015, and that compares to adjustments for restructuring, asset write-downs, and the joint venture that was formed, which in total net to $0.07 of expense for the full year in 2014. Also included in FY 2015 earnings is the $0.38 per share in transactional currency gains that are not expected to repeat in FY 2016, as Tom alluded to earlier. On slide 7, we discuss the influences on adjusted earnings for Q4 versus Q4 of last year. You will find the significant components of the walk from the adjusted earnings of $2.06 to $1.43 for Q4 of FY 2015. The impact of fewer shares outstanding equated to an increase of $0.10 per share. Reductions to adjusted per share income include, one, lower adjusted segment operating income of $0.30 per share, driven by the strengthened U.S. dollar and weakened end markets demand. The impact of the increased effective tax rate, which was $0.30 per share as a result of the shift in the geographic mix of pre-tax profit, as well as the discrete items and an increase in corporate G&A expenses that total $0.13 per share, due in part to the early retirement program in FY 2015 and unusual one-time credits booked in FY 2014 in Q4. Slide number 8 discusses the influence on adjusted earnings per share for 2015 versus 2014 for the full year. On slide number 8, you will find the significant components of the walk from adjusted EPS $6.94 for the full 2014 to $7.25 for the full 2015. An increase of $0.59 was realized from net other income due to, one, the $0.38 of income related to the transactional currency gain, primarily booked in Q3 of FY 2015, and less deferred comp expense booked in FY 2015 of $0.07, as well as lower pension expense in FY 2015 of $0.05 versus the FY 2014. There was also $0.30 from fewer shares outstanding as a result of the company's enhanced share buyback program announced and initiated in October of 2014. Decreases were driven by the $0.33, primarily due to the corporate G&A, $0.23 from a higher effective tax rate, and a $0.02 reduction in adjusted segment operating incomes. Moving to slide number 9, with a review of the total company sales and segment operating margins for the fourth quarter and full year. From a segment standpoint, the total company organic sales in Q4 decreased by 4.9% over the same quarter last year. There was minimal contribution to sales in the quarter from acquisitions. Currency impact as a percent of sales was slightly higher than planned, equating to a negative impact on reported sales of $210 million, or 6% in the quarter. The total segment operating margin for Q4, adjusted for the realignment costs incurred in the quarter, was 14.9% versus 15% for the same quarter a year ago. Restructuring costs incurred in the quarter were $27 million, versus $18 million last year. The lower adjusted segment operating income this quarter of $467 million versus $530 million last year reflects the meaningful impact of the strengthened U.S. dollar against the foreign currencies. For the full year, organic sales in FY 2015, adjusted for the GE joint venture, as represented in the upper-right portion of the page, were slightly positive at 0.6%. The effect of foreign currency translation resulted in a negative impact to reported sales of $546 million, or a negative 4.1% of sales for the full year, which represents the entirety of the sales decline in FY 2015. Total company segment operating margin for FY 2015, adjusted for realignment costs incurred during the year, was 14.9% versus 14.4% in FY 2014, an increase of 50 basis points. Restructuring and voluntary retirement expenses incurred in FY 2015 totaled $50 million. Moving to slide number 10. Here, I'll discuss the actual business segments within Diversified Industrial North America. First of all, for Q4, North America organic sales decreased by 6% as compared to the same quarter last year, and there was a 1.2% negative impact in the quarter due to currency. Operating margin for the fourth quarter, adjusted for realignment costs, was 17.3% versus 17.7% in the prior year. Restructuring and voluntary retirement expenses totaled $15 million as compared to $1 million in the prior year, and adjusted operating income was $244 million as compared to $269 million from last year, which is driven by the reduced volume as a result of the softening trends in key end markets. For the full year, organic sales for FY 2015 increased by 1.2%. Contributions to sales from acquisitions were minimal. The impact of foreign currency translation resulted in a negative impact to reported sales of $50 million, or a negative 0.9%. For the full year 2015, operating margin adjusted for realignment costs was 17% of sales versus 16.7% in the prior year. Restructuring and voluntary retirement expenses totaled $17 million as compared to $2 million in FY 2014, and adjusted operating income for fiscal year 2015 was $972 million as compared to the $949 million from last year. Now continuing to slide 11. Organic sales for the quarter for the Diversified Industrial International segment decreased by 4%. Currency negatively impacted sales by 13.6%. Operating margin for the quarter, adjusted for realignment costs, was 10.9% of sales versus 11.2% in the prior year. Restructuring expenses incurred in the quarter totaled $6 million as compared to $18 million in the prior year. Adjusted operating income was $124 million as compared to $156 million, which reflects the translational impact of the strengthened U.S. dollar as well as, very importantly, weaker end markets. For the full year, organic sales for the fiscal year 2015 decreased by 1.2%. The impact of foreign currency resulted in a negative impact to reported sales of $487 million, or a negative 9.2% of sales for the full year. For the full FY 2015 operating margin, adjusted for realignment costs, was 12.9% of sales versus 12.7% in the prior year. Restructuring expenses totaled $27 million as compared to $99 million in FY 2014. Adjusted operating income for FY 2015 was $611 million as compared to $671 million last year, reflecting the translational impact of the strengthened U.S. dollar. On Slide 12, in the Aerospace Systems, organic revenues decreased 4% for the fourth quarter. Currency posed a modest negative 0.6% while commercial OEM sales for the period were strong. The segment sales decline for the period was driven by lower military OEM and military aftermarket sales volume, and favorable contract settlements recorded as revenue in FY 2014 Q4. Operating margin for the fourth quarter, adjusted for the realignment cost, was 16.9% of sales versus 17% in the prior year. Restructuring and voluntary retirement expenses incurred in the quarter totaled $5.8 million as compared to zero related expense in the prior corresponding quarter. Adjusted operating income was $99 million, as compared to $105 million in the prior year, reflecting the impact of the reduced aftermarket sales volume in the quarter, albeit partially offset by reduced development costs as a percent of sales, which was 7.5% for the quarter. For the full year, organic sales for fiscal year 2015, adjusted for the impact of the joint venture that was formed, increased by 3.7%. For the full year 2015 operating margin, adjusted for the realignment cost, was 13.5% of sales versus 12.5% in the prior year. Restructuring and voluntary retirement expenses totaled $6 million, compared to $1 million in the prior year, and adjusted operating income for fiscal year 2015 was $305 million as compared to $272 million last year, which is largely attributed to the reduction in the development cost as a percent of sales and our increased OEM commercial volume. Moving to slide number 13 with the detail of orders changes by segment. As a reminder, we report orders on a trailing average that are expressed 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 shifted to a negative 9% for the quarter end, reflecting the continued weakness in oil and gas, construction, mining, and agriculture, which represented four important industrial end markets. Diversified Industrial North America orders decreased to a negative 9%. International orders decreased to a negative 5%, and Aerospace Systems orders decreased to a negative 14% for the quarter against very high prior year comps. On slide 14, we are going to discuss the cash from operations for the fourth quarter. Cash from operating activities was $511 million, or 16.2%. This aligns to the same 16.2% of sales for the same period last year. For the full year, cash from operating activities for fiscal 2015 was $1.3 billion, or 10.2% of sales as compared to 11.1% last year. In FY 2014, cash from operating activities was adjusted for a pension contribution of $75 million. There was no pension contribution made during FY 2015. The significant uses of cash during the year, $1.7 billion returned to our shareholders via share repurchases of $1.4 billion and dividends of $340 million, $216 million for CapEx, equating to 1.7% of sales for the year. Now turning to the guidance slide on number 15. Guidance is provided on an adjusted basis. The segment operating margins and earnings per share exclude expected business realignment charges, which are forecasted to be incurred throughout FY 2016. Total sales are expected to be in the range of -3% to 0% as compared to the prior year. Adjusted organic growth at the midpoint is basically flat. Currency in the guidance negatively impacts sales by 1.7%, which is nearly all attributed to the Diversified Industrial International segment. We have calculated the impact of currency to spot rates as of June 30, 2015, and we've held those rates steady as we estimate the resulting year-over-year impact for the upcoming FY 2016. For the total Parker adjusted segment, operating margins are forecasted to be between 15.2% and 15.6%. This compares to 14.9% for 2015 on an adjusted basis. The guidance for below the line items, which includes corporate admin, interest, and our other expense category, is $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 was 140.8 million. On the topic of share repurchase, as communicated during last quarter's earnings call, we remain committed to the $2 billion to $3 billion share repurchase announced in October of 2014. To date, share repurchase spend totals 67% of the low end of the announced repurchase program, and we anticipate that the balance of the commitment for repurchases will be made discretionarily over the remaining 14 months of the program. For the full year, guidance on an adjusted earnings per share basis is $6.65 to $7.35, or $7 at the midpoint. This guidance excludes business realignment expensive of approximately $100 million to be incurred in FY 2016. The effect of this restructuring on EPS is approximately $0.50 for the full year, consisting of $0.20 for restructuring and $0.30 for the Simplification initiatives that Tom outlined earlier. Savings from these business realignment initiatives are projected to be $70 million. Some additional key assumptions for the full year 2016 guidance are: sales are divided 48% in the first half, 52% in the second half. Adjusted segment operating income is divided 45% for the first half, 55% for the second half. EPS for the first half is $2.96, and for the second half, $4.04. The Q1 adjusted earnings per share is projected to be $1.47 per share at the midpoint, and this excludes $0.21 of business realignment expenses, including both the Simplification program as well as our traditional restructuring. On slide 16, we have the major reconciliation of the major components. The FY 2016 adjusted EPS guidance of $7 per midpoint from prior FY 2015 EPS of $7.25 per share. Increases include $0.21 from fewer shares outstanding, $0.19 from increased segment operating income, $0.09 from reduced corporate G&A, and $0.02 from a reduced full year effective tax rate. Key components of the decrease include a $0.68 reduction from increased other expense as a result of prior year other income, the most significant portion having been attributed to the unpegging of the CHF and the EUR during the third quarter. For the full year, $0.38. As you will recall, this resulted in a one-time intercompany settlement gain in Q3. There was also $0.19 impacting this category from increased forecasted pension expense due to updated mortality tables, and finally, $0.08 from increased interest expense. Please remember that the forecast excludes any acquisitions or divestitures that closed or that will close during FY 2016. For consistency, we ask that you exclude restructuring expenses from your published estimates. This concludes my prepared comments. Tom, I will turn the call back to you for your summary comments. Thanks, Jon. We do have some challenges ahead, but the good news about FY 2016 is that with every quarter, we move closer to the bottom of the decline in the natural resource markets as we serve. As we have demonstrated, we perform well in tough times. The bright spot is that we enter our new fiscal year leaner than ever, and we are taking additional concrete actions to further lower our cost structure. We are 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 are implementing at Parker. I am confident we have a bright future ahead of us, and I look forward to sharing with all of you our progress throughout the year. With that, I will turn it over to Mark to initiate the question and answer portion of the call. Ladies and gentlemen, if you have a question, please press star followed by 1 on your phone. If your question has been answered or you would like to withdraw your question, press star followed by 2. Please press star 1 to begin. Your first question comes from the line of Jamie Cook from Credit Suisse. Please proceed. I guess just a couple quick questions. One, on the restructuring and Simplification initiatives. I think you said that you expect a $70 million payoff. I guess more broadly, can you talk about which segments the restructuring and Simplification is aimed at? As we think about the $70 million savings, when do we begin to realize that, I guess would be my first question. Just a little more color on that. My second question relates to just the guidance. I think you said by the back half of 2016, you expect sales to increase. Just a little more color on that, and what gives you confidence that you'd start to see improvement in the back half of the year? Is it just easy comps? Is it an assumption the markets get better? Any color on that? Thanks. Okay, Jamie, I'll start. This is Tom. So there's two questions you've got. I'll start with the whole restructuring Simplification piece. Jon Marten will have a few more details on that, then I'll follow up with your question about the guidance. Okay, so we're introducing this new concept of Simplification, which really isn't entirely new to the company. Let me give a little color on this as far as what we're trying to do here. The focus is to reduce complexity, increase speed, reduce our costs, and improve service to our customers, which ultimately is going to help enable growth. One of the key areas we're going to focus on is first, if you look at our revenue profile, in particular you look at any typical division, you look at the last several percent of revenue, it typically carries a disproportionate amount of costs, part numbers, quote activity. We're going to look at that revenue profile. We're also looking at organization and process Simplification to optimize to that revenue profile. But also basic things like looking at number of layers, spanning controls and those kind of things around organization structure. We're taking a fresh look at our division structure. We are complete believers in the divisional structure. That P&L focus we love. We are going to continue to be a decentralized company. However, as a starting point, we have 115 operating divisions around the world. When we look at those divisions, we see about 20% of them that have overlaps in product charter or product technologies that would benefit from combining them and getting more scale and synergies on both growth and on cost. So we're going to look at that 20%. We'll probably take about 10% of our total operating divisions and reduce that as a result of that overlap. The last area will be around bureaucracy. Just reports, activities, our planning process, you name it. We're going to look at trying to just simplify how we do things. So I'll let Jon Marten make a few comments about how it's going to be spread through the year, so that's the Simplification part. The traditional restructuring will be reduction in forces, plant consolidations, all market adjustments that we're making. So they're really additive. The Simplification of things is around all the things I said, plus the traditional restructuring. So Jon Marten, you can comment on how it times out. 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'll get to the remainder of the savings in the second half. Of course, the 40% of the cost incurred in the second half. That's the way we've kind of got it timed in our guidance. We've got very detailed plans, and we're going to leave it at that for now. Jamie, so I'll go back to your second question, which I'm sure was probably a question everybody has, how did we come up with the guidance? From a process standpoint, this is a bottoms-up process from our divisions. We also build economic models to try to model how the forecast might be, and they happen to converge on about the same number, which is the guidance that we've given you. But the color behind it is, for the first half of the year, we're continuing to see challenges in that natural resource-related markets, so oil and gas, ag, mining, and construction. We expect distribution to continue destocking, particularly for those distributors that have exposure to oil and gas for the first six months. When we look at the year, we see ag and mining starting to bottom at the end of this calendar, so at the end of our Q2, and then our forecast is for oil and gas and construction equipment to bottom at the end of our fiscal year. So we're not really expecting any help from construction and oil and gas. However, the fact that they're not going down as rapidly and they're seeking bottom towards the end of our year, provides less headwind for us. So the natural resource markets are going to either be at bottom or close to bottom. Then the other positive markets where we've seen positive growth throughout this year will continue into next year, and that will provide the growth in the second half. We have easier comps, we'll be at bottom or nearing bottom of those tougher markets, and the positive markets will be power gen, heavy-duty truck, rail, semicon, life science, general industrial, automotive, telecom, air conditioning, and aero, and we see a small, moderate growth for distribution. So that's kind of the makeup of the year and how we came up with a -1.5 for the total year. All right. Thanks. I will let someone else get back in queue. Thanks. Your next question comes from Timothy Thein from Citi Research. Please proceed. Great. Thanks. Tom, just following up on your last comment there, just so I am clear. So you are expecting within industrial globally, the OE versus distribution split, some growth is forecasted for distribution, is, I guess, part one. Then just second, can you provide a bit more detail in terms of the quarter just completed, what you saw in terms of within that order decline, how that mix played out, i.e., distribution versus OE? Yeah, I will start. I am 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. I will let Lee give you color on the current quarter and what we saw, what we are currently seeing. Timothy, this is Lee. I think what I'll do, if it's okay with you, I'm going to comment on the industrial markets and maybe just walk you through the different regions. I'll touch on distribution and OE in different markets throughout those regions and try not to be redundant here. I think there's just three big headwind themes. One is the translational effect currency is having. That's the biggest impact to the top line, no doubt. We've mentioned a couple times natural resource-driven markets. Lastly, I think the third drag would be the continued regional/country weakness in Europe, China, and Brazil. With that as a backdrop, I'll just touch on North America. I'll start with distribution. If we look at FY 2015, distribution did grow organically, but there was absolutely a noticeable slowdown in Q3 and a contraction in Q4, sequentially and year-over-year. Slowdown was largely attributed to those distributors with significant oil and gas exposure. As Tom mentioned earlier, we expect another six months of destocking in that channel before it's worked itself out. On the positive side, we continue to see real positive momentum with our distribution base that is exposed to automotive Tier 1s and machine builders. They all experience growth and continue to throughout the quarter. Talking about oil and gas, continued contraction across all upstream sectors. Offshore activity sequentially got worse since our last call. Land-based activity, sequentially worse, but only mildly so, not at the rate that it was in Q3. On a positive note, we continue to gain market position by helping our customers decrease costs in that sector by really using our system applications, and we've introduced some new technology developments that's really positioned us well as we go forward. Agriculture, I think we know that's soft. Power generation's been a positive for us, almost completely globally, definitely North America, through FY 2015 and Q4. There's been a shift from coal to gas-fired plants, and that's really played well for us in terms of opportunities. The whole renewable energy has been positive for us. I think we've shared with you in the past some of the things out of our Winovation pipeline, but we're really excited about our energy storage business. That continues to gain great momentum in that energy storage space. You may have noticed a recent press release on some significant contracts with Alevo. Heavy truck, Class 8 build rates continue at a high level. We continue to experience growth and positive market position with many of our standard products and subsystems, and we have introduced some new technologies there to aid in emissions controls, which are positioning us even better as we go forward. Mobile, continued softness in mining and CE, as we've talked about. We are bullish on the recent ABI trends. I think that'll bode well going forward. Switching now to Europe. A lot of news about, a lot of questions around green shoots, PMI, et cetera. We have not really seen a significant uptick with our customers, with some exceptions. The export activity out of Germany hasn't been what it was. I suspect that's largely due from the historic pull from China, which I'll get to in a minute. Oil and gas activity has been slow. Many major capital projects that we've been involved with have been pushed out. Distribution performance I would characterize as flat to moderately down throughout Europe. We have seen some positive in construction, although modestly. Agriculture continues to be soft. A couple big forces there. Food prices are low, one, but second, there continues to be a lot of debate over food subsidies or farm subsidies throughout the European Union, so that's suppressing investment. The continued conflict in Russia and the Ukraine have really reduced investments. Truck was a strong quarter. In Europe, there was a really strong residual impact of the Euro 5 truck pre-purchase. We expect demand going forward to be closer to underlying need. In China, we saw modest contraction in Q4 and year-over-year. We see continued weakness in construction and machinery. That's down probably 10% year-over-year off of very depressed FY 2014 levels. Distribution in Asia continues to grow positively. I think, one, it's better same-store sales, to use that term, and then we're continuing to add locations, so that's been a positive. Another positive has really been rail, both in subsystems and components. China's really becoming a producer of choice in Asia and Africa, and we're happy to be a participant in that. Automotive in-plant continues to be positive. I talked about power generation earlier. That is positive, mostly in renewable energy. Lastly, Latin America. I'll touch on this quickly. The story really is around Brazil. I just returned from there a week ago. Significant GDP contraction and weakness really across almost all sectors, with the exception of power generation. We've seen some significant wins in solar and wind power in that area, and the investment plan there is strong. Heavy-duty truck is extremely weak. The natural resource markets we talked about are weak. The one benefit we've had, Petrobras has reduced their planned investments nearly 40% for the next five-year projection, but a strength and emphasis on maintenance of existing infrastructure, and that's really played well for us. So that's a lot there, but it just gives you a quick color on where we saw the quarter. Great. Thanks a lot, guys. I'll turn it over. Your next question comes from Nathan Jones from Stifel. Please proceed. Good morning, everyone. Morning, Nathan. 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'm sure you get some benefit from the new Simplification project that you are embarking on. But can you talk about where the underlying margin improvement is coming from, be it restructuring or new products, et cetera? Nathan, it's really coming from Different areas. First of all, of course, we've been restructuring this year. We did the early retirement program in Q4. We had a significant restructuring that we did in FY 2014. We're glad that we did that. That's going to continue to drive important savings for us in FY 2016. The Simplification program that we're initiating for FY 2016 is going to help us drive margins. We're very focused on driving our margins up, and as we added it all up, we were able to come on an adjusted basis with 50 basis points higher margins in FY 2016 on as reported lower sales. It's going to be that reduction in our fixed cost infrastructure driving the higher margins as well as it's going to be our ability to just further drive our new businesses in new products into increased margins in ways that we have not seen before. When you pull that all together, that gives us this advantage. We're also seeing, as I know you know, 100 basis points higher margins in Aerospace Systems, which is also helping drive the total company's margins up too for next year and is an important part of that. A big part of that increased Aerospace Systems margins is coming as a result of the reduction in some of our development expenses as well as the expansion that we're experiencing in the OEM super cycle commercial shipments. Thanks. My follow-up question is on pricing. You've seen 4% order declines in the third quarter, 9% order declines in the fourth quarter. Can you talk about what impact that's having on pricing in the market and how competitors are behaving, what the competitive environment's like at the moment? This is Lee. Certainly, it is a tough pricing environment. We are pleased, though, we track this very closely with our SPI index, and we are still positive year to date, and we were positive in the quarter. One of the things that we try to do is really address our customers' cost issue. 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 bottom line is still positive. It is a tough environment, though. I do not want to describe it any other way. Are you expecting price to be neutral to positive going forward? We are expecting it basically to be flat in our guidance. All right. Thanks very much, guys. Your next question comes from Ann Duignan from JPMorgan. Please proceed. Hi. Good morning, guys. Morning, Ann. Can you give us some more color on your Aerospace orders? I do not know if I missed it, but I know you said tough comps, but I think you also said that commercial aftermarket was down. You are not the first company to note that, and I am just curious what is going on in commercial aftermarket or if I misheard. Well, I think that in our commercial aftermarket, we're actually up slightly there in our orders. It's not a big move up, but we are up slightly there. From an order standpoint, the major driver for us is military. These orders, Ann, that are really driving our numbers, as you know, are for the military, can be very lumpy, and that was the comparable number that I was talking about, and that's what's really driving the numbers. We're also seeing some move in our commercial OEM business down slightly. But again, that's 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 numbers that are more representative of how we see ourselves going forward, which is indicated in our guidance. Does that help, Ann? Yeah, it does, actually. Thank you. It helps a lot. I've got a lot of questions on that since you've released. Can you talk about your confidence in your outlook for the start of a recovery in distribution in the back half? There isn't much visibility there. Where could you be wrong? Ann, this is Tom. As you know, any forecast is usually wrong the day after you send it out. But I think we have some fair assumptions. We've 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. 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 construction into Q4. If those were to slip at all, that would be a potential risk. But that's 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. But we think that's fair based on all the intelligence that we've been able to gather to date. Are you assuming an increase in rig counts from here, or just we kind of stay at this level and we bump along? Yeah, we're assuming flat. Basically, if oil and gas gets to flat, that becomes a positive for us because it's been such a drag the last two quarters. Sure, I appreciate that. I'll get back in queue. I think a lot of my other questions were answered already. Thank you. Thank you. Your next question comes from Jeff Hammond from KeyBanc. Please proceed. Hey, good morning, guys. Morning, Jeff. Hey, if we could just zero in on oil and gas, I think you've talked about that as being a billion-dollar 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 talked about it being a big headwind in terms of margin mix. There is no doubt about that. If you look at the oil and gas, we have OEM customers that are off 50% with us, so they are going through a big destocking process with us. I think, once we work our way through that, work through the inventory that is in the channel, it will be a little more line pull in terms of demand. I think that will be a positive for us. But we are not forecasting, other than line pull, a big rebound in that market. Okay. Can you quantify what distribution was down in North America in the quarter, and how much do you think of that as just temporary destock versus the underlying short-term demand trend? Yeah, in the quarter, about 4% would be our best guess. And I think a lot of that has to do with, again, just destocking at some of these end markets. Okay, thanks. Your next question comes from Eli Lustgarten from Longbow. Please proceed. Good morning, everyone. Morning, Eli. Morning. Can you hear me? Yes. Can you hear us? Oh, yeah. Fine. One clarification that your guidance has share count of 140.8. I guess you spent a little under $1.4 billion so far. Is the assumption that you are not going to buy back more stock, more than creep for the rest of the year, or you just have not put it in there and that is something we should take out if you spend the other $600 million plus? Eli, it is Tom. Yes, we did not put it in our forecast, but you can rest assured that we are still committed to the $2 billion to $3 billion of share repurchase over the timeframe that we communicated, and that I would look for us to buy. You will see us buy opportunistically, and I would look for you to see us doing that going forward here. Will you say this will go down if you do execute? Right. Can we talk a little bit about your assumption for rest of world profitability? You've got the margins going up anywhere from 50 to 100 basis points on what is likely to be relatively stagnant kind of volume or so. Is that the beneficiary of this program that you've announced this year, and if that way, one equation we're trying to find out, of the $70 million benefits you're getting, where would we see that? Most of it's going to be international, or is it split between international and rest of the world and North America? Yeah, Eli, Jon here. Overall, the benefits of the program we're going to see worldwide. This is a business process Simplification, and it's going to have an impact on our margins worldwide. I think we'll see equal implications for North America as we will for our industrial international businesses there. 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 are 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 2015. 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. We'll see it in Europe. We'll also see improvements in our Asian businesses, too. But I don't want to give you that that's 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 the currency headwinds that we are feeling in some of the countries in Europe. There is a whole host of activities that we are working on very hard here to help drive our margins. Great. Thank you very much. Okay. Your next question comes from Andy Casey from Wells Fargo Securities. Please proceed. Thanks a lot. Good morning, everybody. Morning, Andy. A couple questions. The first one is kind of asking something that's been asked a couple times before, at least, 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'm tracking there with you. Yeah. 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've outlined it, as well as reap the benefits from the prior restructuring that we've done, the early retirement that we've done here in the fourth quarter of this year. And that's the source of the $0.19. 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's one program, and it is externally. But inside, this is many programs at the divisional and 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. I don't want to give you the impression that this is just a big tops-down look at the forecast for FY 2016. This is something that has come up from the divisions like we normally do, and this is the results of that process as we start to review it and make adjustments to our operating cadence around the world. Okay. Thank you. I appreciate that response. If I could push a little bit, John. Sure. If you X out the initiatives that have yet to be done, some of the initiatives you announced today. Yep What sort of benefit is just carryover from what's already been done? Well, we've got $50 million carryover from the effort that we had put together here in FY 2015, and that's really the benefit that we're going to see in next year, and that will be bleeding right into the cost structure in FY 2016. Okay That's one number that we are 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. Okay. Thank you, John. Then in the, excuse me, first half, second half outlook, I just want to make sure if there's 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? Then when you look into the second half, do you expect that to normalize? Excuse me. Right. Good question. I'm going to let Tom is going to comment on that. Andy, this is Tom. As I mentioned earlier, for the first 6 months, we are assuming some destocking in our distribution channel, so that's part of the headwind we'll have in the first half of the year from a revenue standpoint. Okay, thank you. Then one last one, if I could fit it in on 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 booming commercial aftermarket, but we have steady commercial aftermarket experience here in our FY 2015, and that's what we're expecting here for FY 2016. 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'll see in FY 2016 as we saw in FY 2015. Okay. Thank you very much. Okay. Your next question. I am sorry. We will just take one more question, please. Your next question comes from John Inch from Deutsche Bank. Please proceed. Yeah, thank you. Good morning, everyone. Morning, John. Hey, morning. John, 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're taking? That would imply, based on what you said, $14 million or 20% savings in the first half and 56%, or the remainder 80% in the second half. Basically, we're looking at an incremental 120 with that split out. Is that the benefit for 2016? Is that the way to think about it? I think you're right, John. I'm going to have to take a look at my numbers here right now. We've got savings of $24 million that are related to the $100 million in the first half. And we've got a savings of $46 million in the second half related to the back end of the $100 million cost. So the total cost for the program in FY 2016 is $100 million. The total savings in FY 2016 is $70 million. So there's a total net cost of $30 million, which equates to $0.15. That $0.15 is built into our guidance. But a total restructuring benefit, excluding the cost of 120, right? Because of the- That is correct. 50 that you said was That is correct. Okay. 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. Yeah. I'm going to just give you a rough order of magnitude on the organic growth in the second half of FY 2016, 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 2016 Q3 and Q4. With a little bit of recovery, excluding comps baked into that, I'm assuming, based on all of the commentary you've made in this call. Is that about fair? That's right. That dovetails into the comments that we were hearing from Tom and Lee and our slow but sequential pickup starting in the second half, very slow, very modest. And then can I just follow up on the $100 million? You guys had issues in Europe for many years. You weren't the only company. You kind of bit the bullet in 2014 and took some very substantial outsized restructuring in. Here we are heading into 2016, and there's another $100 million, which encompasses Europe. So really, I guess my question is, of the $100 million, how much of that would be structural versus variable? So reduction in force in response to weak markets. Then what is it exactly that you're doing in Europe that you didn't already do through actions in 2014 and 2015? I'm just trying to understand kind of what- Sure. What's really happening here to get up to this $100 million? John, this is Tom. Hi, Tom. There's a difference between what we did before. Before we focused on footprint optimization and classic plant consolidations and those types of things. The Simplification in this, which is 60% of the total restructuring cost, is focused more on organization and process optimization, looking at revenue complexity, and that's global. It's not picking on Europe. It's 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. We're just taking a fresh look at it around revenue complexity, organization complexity, division consolidations, and bureaucracy. I can tell you right now, this has got a lot of energy behind it, a lot of enthusiasm. It's not easy, and it's tough decisions, but there's a lot of interest, because when you do these things right, you're going to be faster to serve customers, and it's going to enable growth for the company. It really sounds, Tom, as if this was probably tied to your own succession as CEO and just kind of a refresh of Win for the most part, versus just making sure that there was nothing in the quarter you said, "Uh-oh, you know what? May is really tough. We're just going to have to get out and bite the bullet and take a lot more restructuring." I'm assuming that most of this, you could call it almost strategic. Is that a fair statement, or is it really just kind of almost balanced based on obviously the short cycle economy, which is pretty tough right now? John, I think you nailed it. This is something that both Lee and I and Jon have talked about, knowing when the succession was going to happen, that this was something strategically that we didn't want to look at. This is really two parts. We're going to do the normal adjustments to the market that we've always done, the classic restructuring or realignment. On top of it, we're going to do these strategic things, which is going to have a much more efficient cost structure and a much better service model for our customers. That's just one element of the refresh Win Strategy. Everybody on the phone, you'll get a chance to hear it in a lot more detail. We called this one out, the Simplification piece, because it's a big part of this year's operating plan. But there's a lot of other things we want to talk to you about all around growing the company faster than the market and expanding margins, which we'll give you a lot more color at IR Day here in September. Fair enough. Got it. Thank you. Okay, well, thanks, John. 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. Ladies and gentlemen, thank you very much for your participation. You may now disconnect and have a great day.